Get the right share for you

A whole host of different share classes - some you may have heard of, others that sound strange and complicated - pepper the reports on how companies are trying to dig themselves out of the recession-shaped hole they face.

For example, the government snapped up £5 billion worth of preference shares in Royal Bank of Scotland last year.

And the banks that propped up fading fund manager New Star before they sold it on owned 94% of the new convertible redeemable preference shares that were issued by the fund management firm.

While you may have heard of ordinary shares and preference shares, there is a massive range of structures that companies can put together to raise capital.
Joss Alcraft, a partner at legal firm Matthew Arnold & Baldwin, says: "Classes of share tend to be either ordinary or preference shares and/or be denoted by a letter.

For example, a company's share capital may consist of A ordinary shares, B ordinary shares and C ordinary shares, each with different rights attached to them."

Investors may also be offered redeemable, convertible bonds, convertible preference, deferred and warrants.

Most UK companies have just one class of share nowadays, but it wasn't always that way. Richard Beddard, companies and markets editor of Interactive Investor, recalls: "Decades ago, unconventional share classes were more common at companies like Whitbread and Young's.

"Investing in non-voting shares was the norm. Many people owned Young's shares for the perks that came with ownership; one of which was a seat at the AGM - a massive knees up."

However, as companies scramble to get more cash from investors and struggle to keep afloat in the economic turmoil, unconventional share classes are starting to crop up again. Let's examine some of the different types that you could be offered or might read about.

Share alternatives

First up, preference shares. These have been in the news a lot, as the government owns billions of pounds worth of preference shares in some of the UK's biggest banks. This has upset their shareholders, as it means the government will get first dibs on dividends in future.

Preference shares are often called low-risk shares, as they give first rights to a dividend ahead of ordinary shareholders, which is useful in bad times. They also rank ahead of ordinary shareholders if the business is wound up. But the dividend is usually fixed and they never share in the growth of the company.

According to Alcraft, another potential downside is that preference shares are usually non-voting - the holder cannot vote at shareholder meetings.
Next, deferred shares. These simply mean that holders of deferred shares will be entitled to a dividend only after a certain date or if profits exceed a certain amount.

Financial website says they can be seen as the opposite of preferred shares, as they rank lower for capital repayment in the event of insolvency.

Certainty plus flexibility

Convertible shares are another type of share class. These are preference shares that can be converted into normal ordinary shares at a preset date and price.

"These combine the advantages of preference shares and ordinary shares," observes Michelle Gibbs, financial planner for IFA firm Helm Godfrey. "Shareholders get the certainty of fixed returns, but also the right to convert to ordinary shares."

According to Adrian Lowcock, senior investment adviser at Bestinvest, convertible shares don't cost the company any money to issue, but act as a sweetener when issuing preference shares.However, he warns: "The disadvantage for existing ordinary shareholders is a potential dilution of their equity stake.

"Also, if the company share price doesn't reach a certain - usually high - price, the conversion rights are worthless. Convertible shares don't usually trade at levels where it is worth converting them."

You may also have come across the convertible share's cousin: the convertible bond. As you would expect, these are bonds that can be turned into ordinary shares.

According to investment house F&C, convertible bonds have undergone a surge in popularity in recent years. Global issuance of convertible bonds hit a record level of $200 billion (£125 billion) in 2007.
James Davies, investment research manager at Chartwell, says: "Convertibles can yield more than high-yield bonds, even though, in many instances, they are issued by investment-grade companies.

Such opportunities don't occur very often, but it's worth considering that the price of convertibles is influenced by the price of the underlying equity and its volatility so don't be fooled into thinking that the bond part of the name means that convertibles are low risk."

The M&G Global Convertibles fund is one of the few UK-domiciled funds that offer pure exposure to this asset class and it has returned 29% over the past year.

The FSA-recognised F&C Global Convertible Bond (euro-hedged), a Luxembourg-domiciled fund, has delivered 19% since October last year.

The warrant
The final share class worth mentioning is the warrant. These give the holder the right to purchase shares in the company at a specific price at a future date. Warrants are tradable in their own right, and their value will go up and down as the price of the underlying shares fluctuates.
"Warrants are highly geared to the ordinary share price and are therefore very volatile. For example, a 1% movement in the share price might result in a 10% price movement in the warrant price," observes Lowcock. He points out that investors could lose out if they don't purchase the shares before the warrant expires.

Gibbs notes that warrants produce no income, as they do not qualify for dividends, and warrant holders have no voting rights.

According to Alcraft, the advantages of warrants include the high liquidity of the market and the fact that you only have to invest a small amount of money to gain exposure to the full movement of the underlying share. "This increases the potential upside," he claims.

Alcraft agrees with Gibbs and Lowcock about the drawbacks of warrants, and says: "It can be difficult to find information about warrants. Not all prices are listed in the main financial press, and information and analysis is scarce."

But it is the convertible bonds and preference shares that financial advisers have their eyes on in terms of expecting an increase in future issuance, and they are the ones that investors should pay more attention to.

Gibbs points out that they offer a fixed level of income that is appealing when interest rates are low, "although the risks involved in holding these shares rather than keeping money in cash should be taken into account".
According to Lowcock, convertible bonds could become more popular. "Companies need to give a reason for investors to lend them money. A good rate of return in this climate would do that. The option to convert gives the investor the choice."

Faced with all these options, it is imperative that investors do their homework when choosing a share class to buy.

One of the most important issues to consider is how secure you believe the company is. If the firm is looking dicey, think about whether you will be first in line to get your money back if it goes down the pan.

This is an updated version of an article that first appeared in Money Observer's March 2009 edition.