Investment Vehicles: listed investments

Investment Vehicles: listed investments

There are two main ways to invest:

Listed securities or listed investments--any share or unit which trades on the stock exchange.  These are described in this chapter.

Managed funds or unit trusts--two names for the same thing:  a fund in which investors’ money is combined and managed as a single pool.  These are described in the next chapter.

 The main categories of listed investments are these:

 ·         ordinary shares

·         Exchange Traded Funds (ETF’s)

·         Convertible Preference Shares

·         reset preference shares

·         property trust units

·         income securities

·         stapled securities

·         debt securities

·         warrants

·         options

Ordinary shares--The people who own the ordinary shares own the company.  The ownership of a company might be divided into say 100,000,000 ordinary shares.  (In this case we’d say the company has 100 million issued shares.)

If you own 100 shares, you own one-millionth of the company.  If you own a million shares, you own 1% of the company.

Suppose this company makes a profit of $200m after tax.  If it sets aside $100m to spend on growth, there will be $100m available to pay as dividends.  This works out to $1 per share.  As all ordinary shares are exactly the same, each is entitled to the same $1 dividend.  If you own 100 shares, you’ll receive $100.

Most companies pay franked dividends, which are discussed in a later chapter devoted entirely to this important topic.

Exchange Traded Products -- Exchange-traded products (ETPs) is the family name for the group of products comprising exchange-traded funds (ETFs) managed funds (MF) and structured products (SPs). They are financial products traded on an exchange that invest in or give exposure to securities (shares) or other assets such as commodities.

Most ETPs generally seek to track the performance of a specified index or benchmark (such as the S&P/ASX 200 index) or a currency such as the USD or a commodity such as gold. Single asset products that track the performance of a specific security, bond or debenture are also available.

Convertible and/or preference shares--These are different classes of shares which have different rights from those attaching to ordinary shares.  Convertible shares, for example, might pay you a fixed rate of return for a number of years before converting to ordinary shares.  Preference shares receive some sort of preferential treatment.  They may have a target dividend which must be paid in full before ordinary shareholders receive any dividends. 

Sometimes these special classes of shares can be quite good.  Your broker should be able to help you figure out whether any of these would suit your portfolio.

Reset preference shares-- Generally companies issue resets at a face value of $100.  They promise to pay dividends either at a set rate (such as $6.00 per share per year) or at a floating rate (such as 2% above the 90-day bank bill rate).  These terms are set for a fixed period, usually five to seven years.  At the end of that period the company has the right to re-set the terms of the offer.  Some resets pay franked dividends while others pay unfranked dividends.

Property trust units--Owning units is analogous to owning shares, but slightly different.  A property trust owns various property assets and makes its money by collecting rent and by buying and selling properties.  A trust pays distributions rather than dividends, and a trust must normally distribute all of its income every year.

A property trust might be divided into 100,000,000 units.  As a unit holder, you’re entitled to your proportional share of the profit.  If you own 10,000 units and the profit works out to 50c per unit, you’ll be paid $5,000.

Because the trusts themselves do not pay tax, they do not have any franking credits to pass on.  However, the trusts are able to pass on certain deductions and allowances, so distributions from property trusts usually have certain tax advantages.  These vary significantly from one trust to the next.

The main forms of tax-advantaged income from property trusts are tax free income and tax deferred income.  Tax-free income is just that:  because of the depreciation and other allowances available to the trust, part of your income may come to you as fully tax free.

Tax deferred income is income in respect of which you pay no tax when you receive it.  It does, however, affect your cost base.  Here's how it works.  Suppose you bought property trust units at $1.00 each.  You received tax-deferred distributions of 10c per unit, paying no tax on that income in the year or years in which you received it.  You then sold your units at $1.10.  When it comes to calculating your capital gain, you reduce your cost base by the 10c, so the gain is $1.10 - 90c = 20c.  This is under your control, as you don't realize the capital gain until you sell your holding.

Income securities--These appeared in the late 1990s and are disappearing fast, although they may still be relevant to your portfolio from time to time.  Issued by major companies, income securities generally have a face value of $100 and pay interest at a floating rate linked to some market rate, such as 1.5% above the 90-day bank bill rate. 

Stapled securities-- Each unit you buy on the market comprises a combination of two or more of the following:  a share in a company, a unit in a trust, and/or a debt security.  These cannot be separated (hence they're "stapled").  Such investments pay both dividend income from the company part and trust distributions from the other part.  Those which incorporate a debt security produce interest income also.

Debt securities--Some companies choose to borrow money directly from the market rather than from a bank.  They do this by issuing debt securities, some of which trade on the share market. 

On maturity the company will either redeem them for their issue price, or the holder may elect to convert each note into an ordinary share. 

Warrants--Warrants are a bit more complicated and come in many varieties.  In general terms, warrants give you alternative ways to benefit from owning shares you otherwise like enough to own directly.  Most warrants give you the right to make a sort of down payment, allowing you to control a number of shares in a particular company without paying the full price for those shares up front.  This can be glorious when the share price goes up, but doubly painful if the underlying share price goes down.  Warrants are discussed in greater detail in a later chapter.

A good advisor will be able to assist you to select warrants which can be suitable for your particular purposes, but make sure you understand them fully before you buy.

Options--In their simplest form, options give you the right to buy or sell a particular share at a fixed price for a specified period of time.  These can be used for speculative purposes or as sensible tools to enhance and protect your portfolio.  You can easily manage your portfolio without ever using options, but if you have a good advisor you can benefit from the careful use of options.

The Mechanics of Buying and Selling

You buy and sell all of these listed securities through a stock broker.  You can trade “at market” which means you’re willing to buy or sell at the current price, which might be up or down by a few cents from the price quoted at any given moment.  Telling your broker to buy or sell at market means to get the deal done at the best price available right now. 

Alternatively, you can place a limit order to buy or sell a share at a particular price.  If you do this, there’s no guarantee your order will be filled.

At any given moment, the price is determined by what buyers are willing to pay and sellers are willing to accept. There is no guarantee these orders will ever be filled.  They will be filled only when there are sellers willing to sell at the price buyers are willing to pay.

Orders are filled in chronological order:  the first order placed at that price will be filled first.  This is a fair and democratic system.  It doesn’t matter if your order is big or small:  if you placed it first, it will be filled first.  All the other orders at that price will be filled in the order in which they were placed.

Finally, note that the share prices you see in the papers are the prices at which the last trades of the previous day were completed.  They do not mean that you can buy or sell at that price today.

Settlement

When you complete a buy or a sell, your account must be settled within two business days.  If you’ve bought shares, you’ll need to pay your broker by the third business day after the purchase.  If you’ve sold, payment will be made to you on the second day. 

CHESS

CHESS stands for “Clearing House Electronic Sub register System.”  Your broker will encourage you to sign up for a CHESS account. 

CHESS is just a way of keeping track of your share holdings.  It replaced the slow, cumbersome, and error-prone system of issuing share certificates.  Under the CHESS system, your shareholding is reflected by a holder statement rather than a certificate.  This is analogous to having a bank account (evidenced by a statement) rather than cash under your bed:  it’s much safer and much smarter!

Participation in CHESS costs you nothing, and gives your broker no particular rights beyond those he already has.  It does, however, enable your broker to do a far better job for you.  It’s much easier to identify your share holdings and settle your trades, which can save you a lot of time and trouble.

At any moment, your broker can print for you a complete list of your CHESS holdings.  CHESS itself sends you a holder statement for each of the shares you hold, so you have paper evidence of your holdings separate from the advice you receive from your broker.

CHESS also assists with the little things, such as changing your address.  If all of your share holdings are on CHESS, you can change your postal address for all companies with one letter to your broker.  Without CHESS, you’ll have to write a separate letter to every single company in which you own shares.

If for some reason you get cross with your broker and want to switch, moving your CHESS account to another broker is quick, easy, and painless.  You do it all with your new broker, so you don’t even have to speak to the old one if you don’t want to.

The alternative to CHESS is issuer sponsorship, which means you have a separate relationship with each company in which you own shares.  Your broker doesn’t know what you have, or even if he does, you’ll have to deliver your holder statements to him before you can sell anything. 

Even then, your broker will have to verify your holdings.  This takes time and makes it impossible to trade quickly if an irresistible opportunity presents itself.  Non-CHESS clients are a nuisance for brokers and unlikely to get snappy service.  Having your holdings on CHESS is one of the basic steps toward ensuring you get good service from your broker (there's a whole chapter about this later) and I promise it’s worth real money to you to be a favored client rather than a nuisance.

Once in a while you do have a good reason to trade shares quickly.  If you have a CHESS account with your broker, you can buy shares and then turn around and sell right away if you want to.  If you don’t have a CHESS account, you’ll either have to pay an extra fee so your broker can request your holder number from the share registry, or you'll have to wait three to eight weeks after you buy, because your broker won’t accept a sell order until you have your issuer-sponsored holder statement.

Conclusion:  sign up for CHESS right away.  To do otherwise is to cause yourself endless aggravation and ensure that your broker moves you right down to the bottom of the list as far as service is concerned.