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Subscription shares

Subscription shares are a balance act (like walking a tightrope!)

A little known way to potentially increase your returns is to buy subscription shares.

These shares are effectively options on specific investment trusts.

A particular subscription share gives you the option – but not the obligation – to buy new ordinary shares1 in a particular trust by a particular date (the conversion date) at a particular price (the conversion price).

High risk, high reward

UK investors can buy subscription shares for the going market price through their usual stockbroker.

Occasionally, you may also be issued them by an investment trust that you already own, as sort of a bonus. You can then either decide to hold them, or else sell them in the open market.

Some examples include:

  • JP Morgan Emerging Market Subscription Shares (Ticker: JMGS)
  • Blackrock New Energy Subscription Shares (Ticker: BRNS)
  • Aberdeen New Thai Subscription Shares (Ticker: ANWS)

Each of these subscription shares offers geared exposure to the investment trust of the same name. I’m not sure exactly how many different ones are out there in total, but I’m aware of at least 30.

How do they make you money?

If you are holding a subscription share when its underlying investment trust’s price moves above the conversion price, then you can potentially make a lot of money (depending on what price you paid for the subscription shares). Returns of 3-4x the increase in the underlying trust’s share price are typical.

How do they lose you money?

If you own a subscription share where the conversion price is less than the underlying share price on the day the subscription share must be exercised, then your subscription share will expire worthless, since the option granted by it is useless (since nobody will buy it, because nobody will want to pay more than the going market price for the investment trust).

In-between these two extremes, you might lose some portion of your invested money if the underlying investment trust’s share price falls between you buying its subscription shares and the day those subscription shares must be exercised – but not by enough to render the subscription shares worthless.

Subscription shares are very risky investments. They are far riskier than conventional investment trust shares, let alone cash or bonds. Any investor must fully understand what he or she is buying, and be ready to lose all the money invested in them. For sophisticated investors only.

Subscription shares are not super simple

The maths may be relatively straightforward at first blush, but subscription shares still fail my KISS rule. Compare:

  • Normal investment trust shares: You are buying into a portfolio of shares or other assets, all of which have a market value. In most cases you can hold the trust for the long term to ride out volatility and benefit from the growth of those assets. You may also be paid a nice dividend.
  • Subscription shares: You buy the right to buy other shares, by some date. In plain speak, you basically buy a piece of paper with a promise written on it. Critically, you can’t hold on indefinitely to ride out any volatility, since subscription shares have a use-by date!

So the first kind of share is a time-honoured investment in a nicely diversified portfolio, the second is basically a bet on stock market prices.

I’m not saying don’t ever buy subscription shares – I own a couple myself – but please do be aware of the risks you’re taking.

Murky matters

Subscription shares also half-fail my suggestion that we avoid opaque or exotic financial products.

True, compared to guaranteed income bonds, subscription shares are probably superior – you can see all the prices in the open, buy and sell as you see fit, and take a view on the underlying trust’s investments.

But I’m not giving them a gold star, for two reasons.

  • First, as we’ll see in a future post, the maths is slightly complicated (though it’s easy to work with rough approximations).
  • Secondly, I don’t think there’s a good reason for subscription shares to exist!

As far as I can see, they are a wheeze dreamed up by fund managers to increase the total size of their funds under management.

True, existing shareholders shouldn’t lose out provided they hold onto any subscription shares they’re given AND they subscribe for new shares when conversion time comes (if appropriate). But I’m still not convinced the whole malarkey is of great benefit to anyone but the manager.2

A safer way to take a high risk

Arguably though, that is all of academic interest to most investors. Most will buy their subscription shares on the open market and sell them if the price goes up, long before the conversion date becomes due.

What that means for shareholders in the underlying investment trust isn’t very relevant to such trading!

Subscription shares are a potentially useful tool for the advanced investor. They allow you to gear up your returns if you have a strong conviction about where the market is heading, while crucially your maximum losses are capped to the amount you invest.

I plan to post more on subscription shares in the weeks to come, so subscribe to get future installments. I’ll look at the maths of how subscription shares can magnify your returns, consider more of their advantages and disadvantages, and take a quick look at a few examples currently trading in the market.

  1. Technically you get the right to subscribe for the new shares, hence the name. []
  2. Managers would also point out that a larger pool of assets under management usually reduces the TER. Which is true, but their fees still go up! []

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{ 12 comments… add one }
  • 1 Surio January 28, 2011, 10:17 am

    @M,
    What’s with these new “spurt” in tutorial posts on the blog? What triggered this change in direction?

    P.S: What’s the difference between the Monevator/Accumulator monikers?

  • 2 Surio January 28, 2011, 10:27 am

    I meant to type, Investor/Accumulator monikers. 😐

  • 3 The Investor January 29, 2011, 10:18 am

    @Surio – Re: The posts, no real grand strategy (alas!), I just go through phases. Also I want to write about these securities but most people haven’t heard of sub shares, so I need to log a couple of posts explaining what they are before I can get into the opportunities/risks in the market.

    Re: The moniker, we’re two different people! The Accumulator is a good friend of mine who’s obsessed with passive investing. Here’s his introductory post.

  • 4 No'am January 30, 2011, 9:03 am

    You wrote “your maximum losses are capped to the amount you invest”. Surely this is always true? One can’t lose more than one has invested, although I suppose one could say that one can lose gains which were made in the value of a stock which were not realised.

  • 5 Surio January 30, 2011, 5:13 pm

    🙂 We like it when you go through phases…. Some of your output gets well-honed.
    And you will be pleased to know, guys without grand plans are all the rage now 🙂

    Re: Accumulator:
    So, I look away from the Net and all the excitement happens 🙁

  • 6 Moneycone January 30, 2011, 6:05 pm

    Commenting from the other side of the pond, subscription shares are quite an interesting concept!

    From gilts to subscription shares, your blog gives a nice overview of the investing concepts in the UK – gives something to compare with the investing concepts here in the US.

  • 7 The Investor January 30, 2011, 11:18 pm

    @No’am — Excellent question! I’ll try to explain more clearly.

    Remember, you’re getting a geared return here with subscription shares. This means that for the same amount of money you could invest in the ordinary investment trust shares, you would get for example 3x the return by buying the sub shares. (The risk that is ‘paying’ for that potential extra return is the chance of losing 100% if they expire ‘out of the money’).

    Another way to get 3x gearing leverage like this, might be to borrow the money to invest. But in that case, your principle could be wiped out AND you’d still owe the money you had borrowed.

    It’s similar with spread betting, when you use say £1000 to take what’s effectively a £10,000 position. If it moves against you too quickly, then you can run through your initial £1,000 and into the red before your spreadbetting company closes you out.

  • 8 darren Ladd October 4, 2012, 12:57 am

    Hi,

    If you have subscription shares and you do not convert them on the exercise date do they continue to exist for the next year/exercise date? Or do they expire?

    Or are are there different types of sub shares that cover this?

  • 9 The Investor October 4, 2012, 8:35 am

    @Darren — You need to go in and look at the exact terms of any particular sub share. Some have several exercise dates and then expire. Some just have one date left (typically because they have already run through a few). You can theoretically have sub shares (or the similar warrants) that do not expire, but I’ve never come across any myself.

    In short, do a lot of research and make sure you know your dates before buying anything. It is very easy to lose all the money you invest in a sub share (although unlike with other forms of leveraged bet, at least it’s capped at that).

  • 10 stuart smith November 26, 2012, 7:13 pm

    I would be most grateful if you could say what happens if you own the shares when they expire and they are ‘in the money’ and you do not sell them.

  • 11 The Investor November 26, 2012, 7:21 pm

    @stuart smith — The honest answer is I do not know, but I’d presume you lose your holding. They are options — the final expiry date is your last chance not to sell them but to use the option they represent to buy more of the underlying at the designated price. If you don’t sell that option into the market and you don’t exercise your right to use it, you’re throwing it away as far as I can see.

    Please do your own research though as I do not know for sure, have never faced that situation, and would never let it happen to my own shareholdings. I might be wrong, and this is definitely not specific advice for any investment you have made or might in the future.

  • 12 stuart smith November 27, 2012, 5:43 pm

    Thank you. As my 1st question on this site I am very impressed with your reply and promptness. I shall ensure I am not in this situation.

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