Instalment warrants nab a big slice of derivatives pie

Instalment warrants have been around for little more than two years, but they are fast becoming a force to be reckoned with.

Instalment warrants have been around for little more than two years, but they are fast becoming a force to be reckoned with.

The first instalment warrant - one issued by Macquarie Bank over shares in Na-tional Australia Bank - made its debut on the Australian derivatives stage in January 1997.

By the end of April this year, however, there were 89 instalment warrants on the market - a growing troupe that accounts for close to 20 per cent of all warrants listed.

The value of instalment warrants traded more than doubled from $205.1 million in 1997 to $509.2 million in 1998 and had already reached $169.8 by the end of the first quarter of 1999.

According to industry pundits, instalment warrants are the rising stars in the retail derivatives market. They have stolen the limelight away from options and are becoming a strong competitor to other products in the already fast growing warrant market.

"There are a number of other warrant products hitting the market, but none are taking off like instalment warrants," says Paul Delange, Salomon Smith Barney's manager of structured equities sales.

The experts believe that instalment warrants are also challenging other invest-ment avenues like margin lending and, even, direct trading in shares. And, most expect the trend to continue as investors increasingly focus on yields.

Bankers Trust Structured Equities vice president Ben Scott says retail partici-pation in the derivatives market is now exclusively in warrants rather than op-tions - and instalment warrants are the growth sector of the wider warrants mar-ket.

"Warrants have been a sophisticated niche product, but we are now taking it mainstream to the person in the street," he says.

Bankers Trust is the biggest player in the instalment warrant market, having is-sued 69, or more than two thirds of the instalment warrants currently listed. Of these, 39 were launched as recently as April, giving this market a major fillip.

More growth is expected with existing competitors like Macquarie Bank (and pos-sibly some new players) set to follow suit with new issues of their own.

"I would estimate that by the end of 2001, all the top 100 companies will have instalment warrant structures on them," Scott says.

Richard Murphy, manager of structured products at the Australian Stock Exchange says: "Warrants have traditionally been seen as high risk, high return products, but instalment warrants are attracting people who are more conservative.

"They want better returns than they get from shares, but they don't want all the risk that comes from options and other trading warrants."

A prime reason for the rising popularity of instalment warrants is that inves-tors are more educated about the concept, thanks to the instalment receipts used by the Federal government in the sell down and privatisation of Commonwealth Bank and Telstra.

Scott says between three to four million people have bought these or some other kind of instalment structure. They are now familiar with the concept, making them potential candidates for instalment warrant products.

In addition, there is so much more information on instalment warrants available these days that investors are becoming increasingly aware of the many benefits they offer, including better dividend yields, franking credits and higher expo-sure to share price movements.

Macquarie Bank division director Andrew Evans says instalment warrants have be-come increasingly appealing to smaller players because they are listed, can be traded on the market and can be monitored on a daily basis.

It is also easier to get in and out of them than marginal lending arrangements, he says.

Godfrey Pembroke's head of research Janice Sengupta says: "In our dealer group we have seen growing interest over the past year in making use of instalment warrants.

"There is a strong appetite for them now and it is likely to grow. Our clients know more about them, making it easier for financial planners to introduce them."

She says instalment warrants provide good opportunities for financial planners and their clients because of the structure and flexibility they offer.

Investing in instalment warrants is very much like buying shares on lay-by. While the details vary from one issue to another, the investor usually pays about half of the value of the share upfront and the balance 12-24 months later.

The investor, however, does not have to pay the second instalment and can simply walk away at the end if she or he wants to.

This means that the risks involved are lower. It has also meant that the invest-ment is not considered to have a debt element - a factor that makes it appealing to superannuation funds.

"We believe that DIY superannuation funds are the largest target market for us going forward," Scott says.

According to Sengupta, instalment warrants offer some of the same advantages of share ownership like franking and voting rights.

"Investors receive the dividend payment even though they paid roughly half the share price. This means that they can almost double their dividend yield, some-thing that becomes very attractive in a low interest rate environment," she says.

Macquarie Bank has issued a unique portfolio instalment warrant where rather than having exposure to just one underlying share, investors get a portfolio of 10 shares.

Macquarie Bank's Evans says this enables smaller investors to diversify their holdings. In addition, they only pay brokerage once instead of ten times for ac-cess to these shares.

According to Sengupta, Bankers Trust's cash back instalment warrant also has ap-peal because it allows an investor to take the shares they already own and con-vert them to an instalment warrant structure.

"This is terrific for people sitting on a share portfolio from which they have already enjoyed good gains," says Sengupta.

"It allows them to sell some of their equity holdings without being liable to capital gains tax. They can just take the cash or they can gain an even broader exposure to the share market," she says.

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