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SCMP Reporter

THINKING of investing in one of the covered warrants that have flooded the market this year?   Buyer beware, financial advisers warn. Warrants are not for the lighthearted. Nor are they a safe haven for widows, orphans or retirement funds.

  'You have to follow the market very closely to make money in warrants,' one personal financial adviser with a European firm said.

  Covered call warrants are much like call options, giving investors the right but not the obligation to buy shares in a company at a certain price before a certain date, in the case of American-style warrants offered in Hong Kong.

  Warrants are highly geared instruments that give investors a chance to take a position on a stock for a fraction of the cost of the underlying shares.

  If the underlying share price rises beyond a certain point, the holder stands to reap a profit far in excess of the original investment. If the share does not perform, the warrant can end up worthless.

  Bull markets tend to bring a flood of call warrants, reflecting a belief that stock prices will continue to rise. This month, issuers have raised about $2.68 billion through new warrants.

   Aggressive investors looking for leveraged exposure have other options - stock options.

  Professionals say there is little difference between warrants and options, aside from the maturity. 'A warrant is essentially an option with a different time value,' one personal financial adviser said.

  Options available in Hong Kong carry maturities of one, two, three, six or nine months, while warrants carry maturities of 12 to 18 months.

  Before a warrant or option expires, it is traded through the stock exchange and the price can swing with much more volatility than the underlying shares.

    Professional investors run complicated computer programs comparing investment potential in combinations of the options, warrants, convertible bonds or just shares in a company.

  'We had one case recently where a warrant on HSBC Holdings was trading at a 30 per cent premium to an option with a very similar structure,' one broker serving institutional investors said. 'We advised our clients to sell the warrant and buy the option.'   Retail investors do not always have the benefit of such professional advice, however, and many individuals are still holding those warrants instead of the options that offer better returns.

  Brokers said exchange traded stock options offered greater liquidity as well because of the market-maker system.

  Market-makers - securities houses that have agreed to quote a price at any time - assure a market where investors can sell if they need to. Warrants, on the other hand, could be so thinly traded that selling could be a problem at times, brokers said.

  Stock options were introduced on the exchange only four months ago on the bluest of blue chips. Most retail investors had shied away from the instruments because, brokers said, the trading strategies appeared so complicated.

  With textbook strategies such as 'buy butterfly' (buy a call, sell two calls at a lower strike and buy a call at equally lower strike for a bearish market with falling volatility), most individual investors are left baffled.

   Professional strategies for trading warrants are no less complicated. The attraction of warrants may simply be that they have been around longer and investors are more familiar with them.

  For a leveraged play on a smaller company, warrants are still the only game in town and no doubt some investors that are not afraid to take a gamble will continue to buy them.

  For investors considering unit trusts investing in warrants, the Japanese market has produced the best - and worst - returns.

  Michael Lindsell's LGT Japanese Warrants and Derivatives Fund has been the star performer over one and three years.

   An investor who placed US$1,000 in his fund would have seen it rise to $2,538 during the past 12 months and giving more than fourfold gains since 1993.

   HSBC Asset Management's and Invesco Asia's warrant funds alternate as the worst performers over one and three years.

    A $1,000 investment in Invesco's Nippon Warrant fund in January last year would have paid management fees to have their capital reduced by $330.

   The same amount invested three years ago in HSBC Japanese Warrant fund would have fallen in value by $349.

   During the past 12 months only nine of the 17 funds have managed to do better than preserve their investors capital. Only seven would have made enough to cover the investors costs.



Call warrants offer risky option