ZDP shares, what’s the deal?

James Smith

Premier Miton Global Renewables Trust Plc

This update should not be taken as advice. If you are unsure about any of the content please contact your financial adviser. Please remember that the value of stock market investments will fluctuate and investors may not get back the original amount invested. To assist, where appropriate, a glossary explaining some of the terms used has been provided at the end of this update.

The current investment environment presents many challenges to the private investor. In some areas, shares are trading at lofty valuations, particularly some of the more exciting higher growth sectors which dominate global equity indices. These may, therefore, offer lower potential future returns than have been enjoyed over recent years, and may also have a higher than usual risk of participating in a market fall. Company shares, or “equities”, are still the investment of choice for the long-term, but for those people with shorter-term investment horizons, or who have a lower tolerance of losing money, they may present unacceptably high risks.

The traditionally safer investment areas of government or quality corporate bonds offer only modest returns and, after taking into account inflation, for the most part commit investors to losing money in real terms. Buying longer duration bonds, i.e. those with repayment dates further into the future, may offer a slightly higher return, but exposes the investor to potential losses if interest rates increase. Buying the bonds of lower grade, i.e. higher risk, issuers offers only marginally higher returns.

It is tempting therefore to hold cash investments at the bank, however there again the interest rates available are negligible, ensuring that over time, given higher inflation, the real value of cash in the bank may be significantly eroded.

One area of investment that is largely ignored by most are Zero Dividend Preference Shares (or “ZDPs”). In fact, I cannot remember the last time I saw ZDPs mentioned either in newspapers or the financial press.

What is a ZDP?

A ZDP is fixed return instrument (a little like a bond) issued by some investment companies or investment trusts. However, unlike a bond, which pays interest in the form of a regular cash payment, a ZDP’s return is rolled up throughout its life in the form of a higher final redemption payment received by the investor at the end of its life (this is the “Zero Dividend” element – note that Zero Dividend does not mean zero return!) However, please note that serious falls in market levels can alter their structure and lead to falling values.

For instance, using the ZDP issued by Premier Miton Global Renewable Trust (“PMGR”) as an example, this ZDP was issued at the end of November 2020 at an issue price of 100p per ZDP share. It has a five-year life, and on 28 November 2025, holders will be entitled to a redemption payment of 126.6111 pence per ZDP share. If held over the entire life of the ZDP, this equates to a return of 5 percent a year.

The other important element of a ZDP share is the “Preference” element. The ZDP share is secured on the value of the portfolio and has a preferred entitlement to PMGR’s assets, effectively meaning that any losses in the portfolio are absorbed first by ordinary shareholders, and only when there is no ordinary shareholder capital left would the ZDP shareholder experience a loss.

To put this into context, at the end of 2021, PMGR’s gross assets (i.e. the total value of the portfolio plus or minus cash and short-term trading balances) was £53.4 million. The value of the ZDP share issue at that date was £15.0 million. The portfolio would therefore have to suffer a very substantial loss of value – of over 70% – before the ZDP shares were no longer covered in full by the Trust’s assets.

Although holders are entitled to a final redemption payment in 2025, holders wishing to realise their investment before this date can sell their shares in the market, and new and existing investors alike can buy ZDP shares in the market. The price of the ZDP will gradually trend toward the repayment entitlement figure over time, and may be affected by movements in interest rates and the level of asset cover in the meantime.

What are the benefits of ZDPs to investors?

Firstly, investors benefit from owning a fixed return instrument, and providing that the ZDP remains fully covered by the underlying assets, investors know in advance what their returns will be. This makes them a good investment to hold for financial planning purposes, such as the need to save for an event in the not too distant future.

Secondly, given their “preferred” status, they are lower risk investments than the ordinary shares issued by the issuing investment trust. Buying ZDPs with good levels of asset cover can shield investors from adverse movements in equity markets, although of course they may still be at risk in more difficult market environments.

Thirdly, their returns are taxed as capital returns for UK investors (tax treatment in other jurisdictions may differ). Investors holding their ZDPs outside a tax wrapper such as an ISA or SIPP can make use of their annual capital gains tax allowance (£12,300 in the 2021/2022 tax year). This may provide a more favourable tax outcome when compared to investments which pay cash returns taxable as income, such as dividends on shares or interest on bonds or savings accounts.

What are the risks of ZDPs to investors?

Investors should understand that the ZDP only has full value if the underlying assets within the issuing investment trust remain at a greater level than the total size of the ZDP issue. Below this level, the ZDP will lose value in line with losses in the portfolio. Please also remember that serious falls in market levels can alter their share structure and lead to falling values.

This calculation is usually referred to as “cover” or the “cover ratio”. This calculation takes the current value of the gross assets and deducts relevant future costs to be charged against the investment trust’s capital for the period until the ZDP’s scheduled redemption date. This is then divided by the scheduled redemption value of the ZDP, i.e. the number of ZDP shares multiplied by their redemption price. For instance, PMGR’s ZDP had a cover of 2.74x at December 2021, meaning that for every £1 of ZDP at the redemption date in 2025 based on current portfolio values, there are £2.74 of assets available as security.

In the period prior to redemption, the ZDP shares may move in price, influenced by general levels of interest rates and also the extent to which cover increases (making them less risky) or decreases (making them more risky).

Other terminology which investors may find useful to understand includes “hurdle rate” which expresses the annual movement in total assets required to meet the ZDP final entitlement exactly at redemption. At December 2021, PMGR’s ZDP hurdle rate was 23.1% meaning that assets could decline by a maximum of 23.1% per year over the remaining life of the ZDP shares and ZDP shares would still receive their redemption entitlement in full.

Another handy figure to note is the “gross redemption yield”, this being the annual rate of return that investors would receive over the remaining ZDP life if they were buying at the current market price.

These ratios are published by investment companies with ZDP shares in issue, usually on monthly factsheets, and may be available from other financial data providers. Additionally, PMGR’s annual report contains a section of “Alternative Performance Measures” (“APMs”) which not only defines the terminology but also sets out the specific calculations so they can be better understood by investors.

What happens on maturity?

Investors often ask what happens on the maturity of the ZDP share. Provided the asset cover is sufficient, ZDP shareholders will be entitled to receive a cash payment representing their redemption entitlement. If the ZDP is not fully covered by assets, the ZDP shareholder might receive a lower amount. The redemption payment may result in the realisation of a capital gain, and a consequent tax liability, taking into account the holder’s specific circumstances.

The directors of the investment trust may, at their discretion, offer a “rollover” ZDP issue, in which case ZDP holders will be given the opportunity to roll some or all of their holding into the new issue. The new issue can be expected to have a different rate of return to the maturing issue, depending on market conditions at that time.

So is there an opportunity here?

Whether an individual ZDP share is an attractive investment will depend on many factors, not only the investment ratios set out above, but also on the type of assets held in the portfolio on which they are secured. For instance, a ZDP secured on a portfolio of infrastructure companies might be lower risk than one secured on a portfolio of pharmaceutical companies. This is a judgement that investors must make for themselves with guidance from a financial adviser.

Like any other investment however, it is important to undertake thorough research, and if necessary seek advice from a financial adviser, in order to understand both the nature and the level of asset cover to ensure that a particular ZDP presents an acceptable risk / return profile for the investor’s own unique circumstances.

Investors with Premier Miton may be covered by the Financial Services Compensation Scheme, which has been established under the rules of the FCA as a “rescue fund” for certain clients of firms authorised and regulated by the FCA which have gone out of business. The scheme covers an amount equal to 100% of the first £85,000 owed to you regarding your investment accounts. You can find out more information on compensation arrangements by visiting www.fscs.org.uk, calling 0800 678 1100 & 020 7741 4100 or by writing to Financial Services Compensation Scheme, PO Box 300, Mitcheldean, GL17 1DY.

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Risks

All types of investment carry a degree of risk.  It is possible you could lose some, or all, of the money you invest. The level of risk varies depending on the type of investment.

Typically, you are less likely to lose money over the long term from an investment that is considered low risk, although potential returns may also be lower. Investments considered higher risk typically offer greater opportunities for better long-term returns, though the risk of losing money is also likely to be higher.

When you invest, it is important that you understand the risk to your money and are comfortable with that level of risk. If you are unsure, we would recommend that you consult a financial adviser.

The value of your investment might not keep up with any rise in the cost of living.

You could lose money if financial markets fall.

The levels of taxation that apply to income or capital gains from the fund, including any tax relief that may be available, will depend on your personal tax situation.

ZDPs have a maturity date, pay no income but pay a set amount at maturity. Serious falls in market levels can alter their structure and lead to falling values.

Forecasts are not reliable indicators of future returns.

Glossary

Bonds (or fixed income)

Types of investments that allow investors to loan money to governments and companies, usually in return for the offer of the pay-out of a regular fixed amount of money until the bond’s maturity date, plus the return of the original value of the bond at a set maturity date. The price of bonds will vary and the investment terms of bonds will also vary.

Capital

Describes financial assets, particularly cash, or other assets, such as shares, owned by a person or organisation.

Dividends

The portion of its capital that a company chooses to return to its shareholders. For a fund, this is the payment of fund’s income to its shareholders. For a trust, this is the payment of a trust’s income to its shareholders.

Duration

A measure of the price sensitivity of a fixed income investment to a change in interest rates.

Equities

Another name for shares (or stock) in a company.

Government bonds

A type of bond, issued by a government. They usually aim to pay out a regular fixed amount of money until the bond’s maturity date, when they also aim to repay the initial investment. In the UK they are called gilts and in the US they are referred to as treasuries

Investment Trusts

Investment trusts are a type of collective investment where a group of investors pool their money to invest in a portfolio of assets. As public limited companies, they trade on a stock exchange so that investors can buy and sell from the market.

Maturity

The set date on which a bond or similar loan will be repaid by the borrower.

Zero dividend preference shares (ZDPs)

Issued by investment trusts. ZDPs have a maturity date, pay no income but pay a set amount at maturity.

IMPORTANT INFORMATION:

The views expressed in this document should not be taken as a recommendation, advice or forecast. We are unable to give financial advice. If you are unsure about the content contained within/suitability of the investments mentioned, please speak to a financial adviser.

Whilst every effort has been made to ensure the accuracy of the information contained within this fund manager insight, we regret that we cannot accept responsibility for any omissions or errors. The information given and opinions expressed are subject to change and should not be interpreted as investment advice. Persons who do not have professional experience in matters relating to investments should not rely on the content of this fund manager insight.

All data is sourced to Premier Miton unless otherwise stated.

For your protection, calls may be monitored and recorded for training and quality assurance purposes.

A free, English language copy of the trust’s full Prospectus, the Key Information Document and Pre-investment Disclosure Document are available on the Premier Miton website, or you can request copies by calling us on 01483 306090.

Financial Promotion issued by Premier Miton Investors. Premier Portfolio Managers Limited is registered in England no. 01235867. Premier Fund Managers Limited is registered in England no. 02274227.  Both companies are authorised and regulated by the Financial Conduct Authority and are members of the ‘Premier Miton Investors’ marketing group and subsidiaries of Premier Miton Group plc (registered in England no. 06306664). Registered office: Eastgate Court, High Street, Guildford, Surrey GU1 3DE.

005624/010322

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The content of the pages of this website is for your general information and use only. It, and the products and services described within it, are subject to change without notice. We shall not be liable to you, or any third party, for any amendment, modification, suspension or discontinuance of any product or service described on our website. Neither we, nor any third parties, provide any warranty or guarantee as to the accuracy, timeliness, performance, completeness or appropriateness of the information and materials made available on this website.

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Disclaimer

This section of the website and the content it contains is for retail clients only and by persons who are resident in the United Kingdom [who are not US persons]. Professional advisers should refer to the Professional Advisers site.

The content of the pages of this website is for your general information only. It, and the products and services described within it, are subject to change without notice. We shall not be liable to you, or any third party, for any amendment, modification, suspension or discontinuance of any product or service described on our website. Neither we, nor any third parties, provide any warranty or guarantee as to the accuracy, timeliness, performance, completeness or appropriateness of the information and materials made available on this website.

You acknowledge that such information may contain inaccuracies or errors and we expressly exclude liability for any such inaccuracies or errors to the fullest extent permitted by law. Your use of any information or materials is entirely at your own risk, for which we shall not be liable.

The information contained on this website does not constitute an offer or solicitation to sell or purchase shares in the funds or portfolios or to provide you with other products or services. Any application or investment must only be made on the basis of the relevant documentation of the investment, such as, for example, terms and conditions. The information on this website does not constitute any investment, tax, legal or other advice. Persons who do not have professional experience in matters relating to investments should always consult with an independent financial adviser before making an investment decision. Any opinion expressed on individual funds, services or products represent the views of the individual at the time of preparation and should not be interpreted as a personal recommendation to buy or sell or otherwise trade all or any of the investments that may be referred to.

Website terms of use: Please ensure you have read and accept the full 'website terms of use' before continuing.

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Disclaimer

This section of the website and the content it contains is for professional financial advisers only and should not be relied upon, or circulated to, retail clients. Retail clients should refer to the Private Investor's site.

The content of the pages of this website is for your general information and use only. It, and the products and services described within it, are subject to change without notice. We shall not be liable to you, or any third party, for any amendment, modification, suspension or discontinuance of any product or service described on our website. Neither we, nor any third parties, provide any warranty or guarantee as to the accuracy, timeliness, performance, completeness or appropriateness of the information and materials made available on this website.

You acknowledge that such information may contain inaccuracies or errors and we expressly exclude liability for any such inaccuracies or errors to the fullest extent permitted by law. Your use of any information or materials is entirely at your own risk, for which we shall not be liable.

The information contained on this website does not constitute an offer or solicitation to sell shares in the funds or portfolio or to provide you with other products or services. Any application or investment must only be made on the basis of the relevant documentation of the investment, such as, for example, terms and conditions. The information on this website does not constitute any investment, tax, legal or other advice. Persons who do not have professional experience in matters relating to investments should always consult with an independent financial adviser before making an investment decision. Any opinion expressed on individual funds, services or products, represent the views of the individual at the time of preparation and should not be interpreted as a personal recommendation to buy or sell or otherwise trade all or any of the investments that may be referred to.

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