What are the advantages of investing in instalment warrants for a DIY super fund?
An instalment warrant gives an investor the right to buy shares, or other underlying assets, by payment of several instalments (usually two) during the life of the instalment. Investors have direct exposure to the capital growth of the underlying share and receive dividends and available franking credits paid on those shares.
Generally, an instalment warrant price is usually 50% of the market value of the underlying share at the time of issue. The amount of the final instalment is generally fixed and represents a loan by the issuer, which investors can choose to repay on exercising the instalment.
Instalment warrants are available to individuals, companies, trusts and superannuation funds.
Investments by superannuation funds into instalment warrants has been a long standing practice that is widespread in the market, even prior to the Government’s recent changes to the Superannuation Industry (Supervision) Act 1993. Superannuation funds must still comply with other superannuation rules, including, for example, they must not result in fund assets being subject to a charge.
Advantages of investing in instalment warrants
Instalments offer many benefits and strategies to instalment warrant investors including:
Leverage – Because a lower initial amount is outlayed to purchase an instalment warrant, an increase in the value of the underlying share will result in a proportionally larger increase in the value of the instalment warrant. Further, an investment in an instalment warrant will produce a higher percentage return than an investment in the underlying share, provided the price of the underlying share increases.
Diversification – Instalment warrants give investors the ability to diversify their exposure to the sharemarket because they are only paying approximately 50% of a share price for the same amount of exposure. The other 50% may be used to invest into other assets.
Enhanced dividend yield – investors are entitled to the full dividend and available franking credits paid on the underlying share, even though they have only partially paid for the share. The dividend stream represents an enhanced yield compared to the income received through a direct share investment.
Enhanced franking credits – In the case of a superannuation fund, available franking credits can be used to offset tax on other income earned by the fund, and tax payable on contributions made to the fund. Franking credits represent tax already paid by the company that pays the dividend. Currently, the company tax rate in Australia is 30% – tax payable on superannuation fund earnings is currently 15% (or 0% if the superannuation fund has moved into pension phase). This means that superannuation funds are entitled to a 15% refund (i.e. the difference between the tax paid by the company and the superannuation fund rate).
Prepaid interest deductibility – the first instalment paid to purchase an instalment warrant has an interest and fee component. These are the costs associated with the loan amount the issuer is providing investors. Depending on an investor’s circumstances, these costs may be claimed as a tax deduction. It may be possible to claim a deduction for as much as twelve months’ prepayment of interest, or in the case of a superannuation fund, it may only be possible to claim a deduction for accrued interest.
For more information
For further information on Instalment Warrants, visit the Australian Securities Exchange website. The ASX have a booklet titled ‘Understanding Trading and Investment Warrants’ which is designed to give you a comprehensive understanding of the different types of warrants and how they work. A number of Instalment Warrant strategies are also available for download.
By Matt Comyn, General Manager, CommSec
The views expressed in this article are those of Matt Comyn, a representative of Commonwealth Securities Limited (CommSec) ABN 60 067 254 399 AFSL 238814. Commonwealth Securities Limited (CommSec) ABN 60 067 254 399 AFSL 238814 is a wholly owned but non-guaranteed subsidiary of the Commonwealth Bank of Australia and a Participant of the ASX Group. The information in this article is general in nature and does not take into account any investor’s particular objectives, financial situation or needs. In considering its appropriateness, investors should read the relevant product disclosure statement and consult a financial adviser before making an investment decision. Except to the extent that any liability under any law cannot be excluded, no liability for any loss or damage which may be suffered by any person, directly or indirectly, through relying upon any information or statement in this document is accepted by the Commonwealth Bank or CommSec or any of their directors, employees or agents, whether that loss or damage is caused by any fault or negligence on their part or otherwise. Commonwealth Bank and its subsidiaries do not guarantee the obligations or performance of CommSec or the products or services offered. CommSec offers a product similar to that mentioned in this article. Please call 13 15 19 to obtain a PDS which outlines the associated risks and costs.
Information contained in the brochure entitled “Understanding Trading and Investment Warrants” is produced by ASX Operations Pty Limited ABN 42 004 523 782 (‘ASX’) and intended for general information only. Neither ASX nor any related body corporate of ASX has had any involvement in the preparation of any part of this document, accepts responsibility for any statement herein, or has been involved in or consented to the issue of this document.