John Cobb of sharebrokers J B Were is one adviser who is keen on using endowment warrants in investors' portfolios as a way of getting exposure to equities in a tax effective manner.
Cobb says he won't use warrants, just for the sake of using them, nor are they suitable for everybody. However, they are, he says an effective way of using equities for people dedicated to a long-term investment strategy.
The main advantage of warrants is that investors get exposure to listed Australian shares for a very low cost.
Because of the leverage factor, they "are suitable for people looking to make capital gains". Cobb is keen to stress Endowment Warrants are not suitable for people looking for income, as the future dividends are used to pay for the shares over the 10 year period.Cobb also points out that the New Zealand market is much more suitable for investors seeking income as it has a very high dividend yield, both historically and on an international basis.
The other attractive feature of Endowment Warrants for New Zealand investors is that they are tax effective.
Currently New Zealanders holding Australian equities directly can't use the franking credits attached to dividends, and they have to pay tax on the income when it comes back to New Zealand.
Although investors still can't get access to the franking credits by using Endowment Warrants, they escape having to pay tax to the Inland Revenue Department as all of the dividends are reinvested back into the share, rather than brought back to New Zealand and taxed.
Cobb says there is a specific type of investor Endowment Warrants suit. "In the right situation we would use them quite aggressively."
He says there is slightly more risk involved in warrants than the physical share, and that is why research is so important in the process.
Because the warrants are leveraged actual share price movements are magnified, so while the values can rise quickly the reverse is true also.
Cobb says Endowment Warrants are a useful alternative to margin lending which is more commonly used by sharebrokers as a way of achieving leveraged equity exposure.
He says there is no real competition between the two forms of investment, rather they are suitable for different types of investors.
"Margin lending tends to be for those people who tend to be a little bit more comfortable with gearing."
With Endowment Warrants investors aren't taking on the same level of risk as margin lending.
Cobb says with Endowment Warrants investors have the option of walking away from the investment if they desire.
The big attractiveness, and security of Endowment Warrants is that investors know they have the underlying stocks.
"At the end of the day it is the shares we are buying," Cobb says.
He is selective about what shares he buys Endowment Warrants over, as the success of the warrant is related to the success of the underlying stock.
"The first step is asking do you really want to buy this share?" If the answer is yes, then the question is do you want to buy the physical share or the warrant over it?
For that reason good research on stocks is "absolutely crucial".
His current favourites are the banking stocks such as National Australia Bank and Commonwealth Bank of Australia. However, a significant number of clients had bought AMP warrants and resource stocks, such as Western Mining and Woodside Petroleum, which both look cheap at present, were also in favour.
Following the AMP share giveaway some investors chose to keep the same number of AMP shares they were allocated in the demutualisation process, but to free up some cash they sold the physical shares and bought warrants covering the same number of shares.
Cobb says there is no problem with liquidity as warrants are listed and Macquarie Bank, the issuer, makes a secondary market.
Cobb says Endowment Warrants appear to be complex, however he reckons once he sits down with an investor they are not too difficult to explain.
