Foresight Capital Partners

Today in Woolworth’s (UK store) I noticed a mobile phone with mp3 player, 1.3M pixel camera, and it take memory cards and all for 39.99 GBP (actually it turned out it was 69.99 GBP but it had a 30 GBP calls voucher bundled). For those not in the UK, Woolworth’s is just a standard high street store, with real over heads to pay and even so this seems like a rather nominal price for nice functionality in a compact package. Anyway, after closer inspection the interesting point was that the phones branding only had Virgin Mobile, i.e. no phone manufacturer.

After doing a little research it seems that the mobile provide (i.e. the people with direct access to customers) are doing deals with mobile phone manufacturer in China and just cutting out completely the Nokia’s of this world. By doing so they are able to knock-off 30% of the price they can offer hand-sets for. Moreover the mobile phone company gets complete control over the branding and with there Chinese partners have been able to even customize the phones hardware and software for there exact requirements. This seems like a rather compelling business model, where the Chinese manufacture is able and encouraged to moved up the value chain by offering better and better functionality and the mobile network provider can offer a compelling offer. In fact, those provider who do not take this route may find it harder and harder to compete.

Anyway, I’m off the watch a bit of Bloomberg TV, the DOW today traded at all-time record intra-day highs and it may even close at a new closing high. As I said I last month all the negative commentary was a bit over done.

As a general guide of Offshore Tax planning I would recommend the TaxCafe guide:

Non-Resident and Offshore Tax Planning
http://www.taxcafe.co.uk/non-resident-offshore-tax.html

it accessible, easy to read and tells you what you need to know and nothing more (which is a great feature of any tax guide). You can buy it online and once the CC purchase has gone through you will be emailed a PDF copy and receive the hard copy in a week or so. TaxCafe also provides a book entitled ‘Worlds Best Tax Havens’ which I found less useful (compared with the first guide) but still a useful book to have on your bookshelf.

A work with is not concise but is very interesting is:

Offshore Tax Planning, 12th Edition
By Giles Clarke, MA (Cantab), PhD, FTII, Barrister
http://www.lexisnexis.co.uk/marketing/campaigns/taxation/offshore_tax_plan.html

at 120 GBP its not cheap, but it is certainly more economical buying this book than getting the some information out of a specialist tax lawyer. It is a rather technical long book but if you are seriously about planning complex issues such as Inheritance Tax (IHT) using offshore structures then time invested reading this work, or at least portions of it is time well spent. Please note that even after reading such works you are likely to still need the services of the specialist lawyer but at least you will be in a position to have more informed discussions with the lawyer and hopefully arrive at a better final solution as a result.

Even today on Yahoo! Finance I came across two articles which essentially concluded the exact opposite thing, namely that the US House Market slow down will cause a crash/rally in US stocks. Confused!, me to, the particular reports are:

Prepare for a U.S. Market Crash - Motley Fool
Housing slump woes could be Wall Street’s gain - CNNMoney.com

what is interesting at present is not only the particular views held which tend to get endless repeated but how much divergence there is in the commentary.

Listening to market commentary can often drive you completely nuts. Financial news channels such as Bloomberg TV and CNBC are a hot-bed of market commentators and such media content achieve a wide audience among market professions and active private investors. Bloomberg TV and CNBC do provide value and personally though I do not go in for all the market commentary I do like the more purely news reporting on Bloomberg TV such as the ‘US Market Wrap-up’ (at 9pm GMT) and ‘after the bell’ (soon after) which really can be quite good, maybe even enjoyable. Particularly, for investors based in the UK timezone who want to keep a tab on US markets but also do not want to be sitting in front of a PC after 9pm.

Now going back to market commentators just to give you an example of what I am taking about, at present there are some commentators who I will not name (but who you can regularly hear on CNBC) who claim that in the next few months before the end of 2006, the FTSE will drop 25%. In particular, one commentator claims this year the market will trend upwards to around 6,000, before selling off and hitting a low around 4,500 before rallying towards the end of the year. Sounds like a bit of an Oracle to me and unless this individual has supernatural powers I really cannot see how such statements can be made with any certainty. After all the only certainty in financial markets is that they are uncertain. However, what is a certainty is that if you want to buy more details regarding this commentary/research then you will need to part with 500 GBP for 12 monthly issues.

So lets take a closer look at these predictions. Now the up move has played out but since most years in history are up years this was never much of a call. The commentator also claims interest rates will fall later this year and next but this information follows from just reading off the yield curve which has been predicting this exact out-come (at least) over the last 10 months. All the commentator is doing is reading off the yield curve which the bond market crowds activity has produced for the benefit of the stock market crowd. If you do not believe me then take a look at: US/UK Yield Curves.

Anyway, where I differ is the call for an “up to 25% fall in equity prices by the year end”. I assume the 25% fall is from the top, i.e. he is calling for the FTSE to hit:

6,000 * (100-25)% = 4,500,

some time this year. Now, maybe I am involved in wishful thinking, maybe this guy knows something I do not know or understands ideas which are beyond me. But at the present point in time, my view of (my) reality tells me that such an event is just not going to happen. Moreover, if I did (even to a degree) believe such an event may happen then I would be gearing up on (out-of-the-money) put options, for example the ones listed at: FTSE Covered Warrants, since the writers of such securitised equity options (from the prices at least) believe such an event to very unlikely indeed.

The reason why I am going on about this, is not because I actually enjoy writing post on the web which criticizes other people. But because I worry other people will take such views on board without really thinking through the commentary or analyst for themselves. As we will see taking such commentary at face value really can be a bad approach.

For example, going back to May 2005, the article Summer shares - Should you sell? by Naomi Caine appeared in Money Weekly Magazine, and informed us of the then views of a number of market commentators. In particular, quoting from the article:

Robin Griffiths of Rathbones is one of the most closely heeded chartists. He thinks shares could even nosedive to as low as 3,277 – the same level as the nadir in 2003….

Other chartists are similarly downbeat. John Prior, a chartist at Killik, the stockbroker, says: “A drop to about 4,500 in the next 12 months would not be surprising.”

David Schwartz, the stock-market historian, believes the bear market has already begun and that the FTSE 100 index will fall to 4,500 by the end of this year….

Unfortunately, at least for the three commentators in question we now know that the views turned out to be mis founded. Moreover, if you had had been in cash (or worst still gone short) then you would have missed out on a market which moved healthily forward by around 15%.

If you are primarily interested in producing income for the long term then buying into a closed-end fund may not be the right approach since:

• A fund will typically pay-out less than the full dividend stream from the underlying investments. Moreover in a typical case the costs incurred from running the fund will be split 50/50 between the capital and income accounts of the funds. That is, half the funds management fee and management costs will come from the income steam (which is mostly dividends) further lowering the amount which can be paid out.
• Dividends are historically much more predictable than capital growth since a companies management will generally eer of the side of caution when deciding on the dividend level to ensure that they can be reliably paid and reliably increased. The most likely reason for this is that any cut in a companies dividend in most cases results in many of the senior management being relieved of their posts. Where as capital growth depends on the behavior of other market participants which is much less predictable.

What are Equity Warrants?

Investment Trust warrants (see Trustnet’s list) are all examples of what is referred to as equity warrants which are a close relative of the familiar vanilla call options. Equity warrants are issued by a company in its own stock and are settled by the company at maturity by issuing more stock to warrant holders for a given predefined price (i.e. the strike). The feature of issuing more stock produces an effect known as dilution, since warrant holders have the right to purchase a stock as a pre-defined price not in the present capital structure of the company but in a new capital structure where there will be more shares in issue, that is, a structure where the earnings of the company are dilution over a larger number of shares. If you wish to read-up a bit further of equity warrants then I recommend the guide provided at: Incademy.

Equity Warrants offer a clean exit at maturity

Now equity warrants have the useful feature that even if you do not choose to exercise the warrants in order to obtain the underlying stock, then they will still pay-out their intrinsic value. The mechanics of how this is achieved in that the trustees of the fund will exercise all warrants which have not been exercised which have a (positive) intrinsic value, they will then buy-back the new stock issued at the market price, the strike of the warrant is then deducted from the buy-back price and what remains is returned to the original warrant holder. What this means in practice is that at the maturity of the warrant you always have a clean low cost exit route, where (exiting) dealing costs will not eat into your profits. Remember the spread on equity warrants such as PLIW.L, can be more than 3% and if you want to trade in any volume (i.e. more than say 10K GBP at a time) then the market makers may only offer you a bid outside the normal spread.

Building and unwinding positions in Equity Warrants

Typically with assets such as equity warrants you will need to build or unwind a position of any size over several days or weeks. This can be time consuming exercise, which will consist of a game of cat-and-dog you will need to play with the market makers. Games such as this do have a hidden cost in that they will eat into your investment research time, naturally you do not need to play this game but then you will end up sacrificing a large portion of your return to the market makers. Remember the mechanical performance enhancing parts of investment are the easiest parts to get right, and though getting good fills on exiting illiquid positions can be a tedious exercise, all investors should be putting in the effort and diligence to obtain this.

I was playing this game over the post Christmas 05 - early January 06 period when I unwound my own holdings in PLIW.L. Now when I was unwinding I typically placed a 5K GBP limit sell order at the best market making quote, typically I put the order in after 2pm when the US was active and typically spreads improve. If it filled, I updated my records and then sometimes placed another limit order (of similar but not exactly the same size) or waited to the next day and repeat the process.

Investment Trust (IT) Equity Warrants and Window Dressing

The reason why I selected the post Christmas - early January period in particular to unwind the position, is because of a phenomenon known as ‘Window Dressing’. Now a fund manager such as Mark Barnett of PLI.L can buy back the stock in this own fund using fund monies. By buying back the fund in the end-of-year period when liquidity is rather low, a manager will typically be able to narrow the discount at which the investment trust trades without needing to trade is particularly large volumes. The reason why managers such as Mark are particularly interested in the end-of-year period is that typical bonus and performance figures are typical based on the traded price of the fund at the end of the year. By selling into this manager generating buying can often be an ideal time in which to exit such funds, as was the case this year with PLI.L and PLIW.L.

Example of a Equity Warrant Investment

I detail a particular Equity Warrants investment within the post PLIW.L Equity Warrants Matures.

The PLIW.L equity warrants for PLI.L (Mark Barnett’s, Perpetual’s Income and Growth) matured today and came through at 131.237p, the relative performance vs FTSE so far this year is as follows:

Note: For details of the investment trust Perpetual Income and Growth we refer the reader to Trustnet It.

Now, though PLIW.L out performed the FTSE 100, by 7.53/4.53 = 166%, one would expect this sort of outperformance for the following reason. The average PLIW.L price over period of 125p, allowed control over an average underlying asset (PLI.L) of 225p over the period implies the warrants had an implies average gearing of 180% over the period. For all you quantative analysts out there, I realise this is back of an envelope stuff (i.e. not 100% rigorous) but I am just using it to illustrate a point. Hence to summarize, in the term of risk adjusted performance the performance was broadly in line with the FTSE 100.

Further details concerning Equity Warrants

Within the post Investing in Equity Warrants we detail a number of practice issues associated with investing in Equity Warrants such as PLIW.L. These including an introduction to Equity Warrants, how one can efficiently trade in and out of positions in Equity Warrants, how and why Equity Warrants often offer a clean exit at maturity, and for Investment Trust Equity Warrants how the phenomenon of ‘Window Dressing’ of investment trusts can effect the associated Equity Warrant.