'The overlooked investments offering 5pc tax-free'

Glen_Clark

Any thoughts on these ?
http://www.telegraph.co.uk/finance/personalfinance/investing/11078312/The-overlooked-investments-offering-5pc-tax-free-returns-zero-dividend-preferences-share.html

Daniel_Elkington

Hi there, they are medium-high risk investments offering a limited return. Limited upside, however they don't always limit the downside risk.


I don't like them. I wouldn't take the telegraph seriously when considering a financial recommendation. Journalists make terrible financial advisers.

bowlhead99

Daniel_Elkington wrote: »

I wouldn't take the telegraph seriously when considering a financial recommendation. Journalists make terrible financial advisers.

I would second that, however they have a use in that they can make you aware of things that you can then go and research properly.

they are medium-high risk investments offering a limited return. Limited upside, however they don't always limit the downside risk.

I don't like them.

This is true. Same could be said for my LLPC prefs yielding 6-7% with no real upside beyond that and a chance of losing tens of percent - but I still hold a fair chunk of them.

ZDPs can be useful for tax planning; they are effectively a bullet loan that gets paid back at a premium all in one shot rather than paying a regular interest coupon. For a UK taxpayer the return is characterised as gain rather than interest income as you're buying a preference share and not a loan note. If you're an overseas taxpayer that may not hold.

Like bonds and other dividend-paying prefs they rank above equity and risk/reward is similar to a regular bond or redeemable cumulative preference share maturing in a similar timescale. The overall return for holding to maturity might be slightly better because if you held a bond or a paying pref you would have the certainty of receiving coupons or dividends reducing your exposure while with a ZDP you only get paid once at the end and have to hope they have the liquid assets or the ability to refinance at that time to pay you back. It has been a common way of financing some listed real estate and private equity vehicles (as shown on the telegraph article). Looking at the ones they mentioned in the article, all seem to have adequate assets to meet the obligations.

It's important to research each of the companies / trusts to check what that asset cover actually means. For example JPEL only needs less than 40-odd million to pay off its 2015 ZDPs, while it has hundreds of millions of illiquid private equity assets. The telegraph says it has current assets (or perhaps they mean current assets plus available bank finance facilities) of 3x the ZDP obligation. But it's a fund-of-funds: if we go through a shaky period in the market where it is not receiving much in the way of investment returns and realisations, it would be feasible for it to need to pay out a lot of cash to meet capital calls from its investee funds without seeing much back, and thereby reduce the current assets cover. With such a large investment base I wouldn't see any problems getting bank finance or simply a new ZDP issue to keep it well in funds to pay off the maturing 2015 instruments, and would have no qualms about buying it, although I haven't. But risks always exist, which is why the returns they pay are higher than a fixed term cash deposit for the same time period.

Some issuers will have a few different series in issue at a point in time. For example JPEL has 2015 ZDPs and 2017 ZDPs. The 2015 ones (JPZZ) were at a bid price of 85p all Friday and they mature at 87.3p next October, while the 2017 ones (JPSZ) had bid price of 97.25p and mature at 107.1p two years after the others.

The Telegraph says the 2015 ones were on a 3.4% effective yield to maturity, which you would not get if you were buying at full bid price on the numbers I quoted. They have most likely used mid price and therefore effectively the yield is what you'd be giving up if you had those assets and exited them, rather than what the brokers say you could actually buy in for after transaction costs and spread. However, these instruments are thinly traded and trades generally go through well within the wide quoted 1p spread - the only two trades on Friday were 84.325 and 84.417 versus bid/offer of 84-85p.

Overall a perfectly valid investment class as long as you understand it. Fair to say that ZDPs and splitcap trusts etc have a tag of 'not for widows and orphans' as they are perhaps less easy to understand than some mainstream investment choices. But actually some of the ones mentioned in the article could be perfect for widows and orphans looking for a decent stable return in times of low interest rates as long as they recognise there's no such thing as a free lunch and you can't get reward without some form of risk.