The major player in Australia’s warrants market, Citi, has launched the first unleveraged warrants over ASX listed securities. Called Bonus Certificates, these warrants offer investors a lower risk profile than traditional warrants, and may suit SMSFs and other investors who want a degree of protection without overly limiting the upside potential of share investing.
Citi says that in Europe, Bonus Certificates have been particularly popular, and in the largest market Germany, the volume of certificates exceeded the volume of traditional leveraged warrants at the end of 2015. In this product road test, we will see how they shape up for the Australian market.
What are bonus certificates?
Bonus certificates are like buying a share in that you pay the full amount up front. They include a bonus level that is higher than the spot price of the underlying share at issue, and a barrier price that is below the spot price on issue.
At maturity (typically around 12 months), the investor receives the bonus price provided the barrier price is not breached during the term of the investment. If the underlying share trades above the bonus price or below the barrier price, the investor participates in the full upside or downside of the underlying share.
Because the barrier is usually set quite a bit lower than the underlying share price, the investor gets partial downside protection, while being able to participate in the full upside.
Let’s take an example.
On 9 March, Citi issued bonus certificates on a number of shares, including Commonwealth Bank. These mature in 13 months’ time on 17 April 2017.
CBABOA (the ASX Code for this series) has a bonus percentage of 3%, and an initial issue price of $76.31. The bonus level is $78.90, and the barrier level is $56.50.
If during the 13 months CBA shares don’t trade below $56.50, the investor will receive at least $78.90 on maturity.
If CBA shares are higher than $78.90 on maturity (say $85.00), then the investor will get the actual value of CBA shares (ie $85.00). If the barrier is breached and CBA finishes on 17 March at $50, the investor only receives $50, and if they purchased the bonus certificate on the issue date at $76.31, will have lost $26.31.
[1]CBABOA are traded on the ASX, and the price changes in line with movements in the price of ordinary CBA shares. The bonus level and barrier level are fixed for the duration of the certificate.
The catch
It is not so much a catch, but there is always a cost when it comes to a structured product like this. Otherwise, Citi couldn’t afford to provide the partial protection.
With these warrants, you won’t receive any dividends. So investors in CBABOA potentially forgo around $4.20 in dividends, plus associated franking credits. For an SMSF in pension, this is worth around $6.00, for a fund in accumulation phase, around $5.10.
For taxpaying investors, another small downside is that according to the tax advice in Citi’s PDS, gains on bonus certificates will be treated for tax purposes as income rather than as capital.
Eligible securities
Citi says that in due course, it might have 100 bonus certificates listed. Its initial offer is 35 listed companies such as BHP, CBA and Telstra, and one index – the S&P/ASX 200. All series mature on 17 April 2017.
Who might they suit?
Citi’s bonus certificates work best for investors who feel that the market is flat to falling, or who want some level of downside protection, but also want to be able to participate if the market goes higher.
Go back to the CBA example, these warrants provide protection down to $56.50, still 20.2% lower than Friday’s close. And you can participate in all the upside, except the dividend and franking credits.
Our verdict
While I have never been a huge fan of structured products, this warrant meets a need, particularly for conservative investors who may be a touch wary about taking on sharemarket exposure. The BHP bonus certificate (BHPBOA) is a good example. It has a barrier of $12.80 (21% below Friday’s close), and a bonus level of $18.40. There is not much dividend to give up, so for investors who may want to get some exposure to BHP, a case can be made that this is a lower risk way to do it.
Warrants are traded on the ASX through your broker. Before you trade, you will be required to read the ASX’s explanatory booklet Understanding Trading and Investment Warrants [2] and sign a risk disclosure statement. Citi says that both individuals and SMSFs can use Bonus Certificate Warrants.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.