Group's ratings system is designed to help investors choosing zero dividend preference shares
Intermediary group Bestinvest has introduced a rating system to help investors select individual zero dividend preference shares and avoid those still at major risk.
The system is based on the group's evaluation of three factors to identify the main characteristics of each zero. These are its portfolio quality, its gearing and its hurdle rate.
The quality of a zero's portfolio is split into four categories labelled A to D. Category A shows the zero is invested in mainstream equities, category B indicates it is invested in specialist companies, or up to 10% in income shares or high yield bonds, category C shows up to 25% of the portfolio is in income shares and/or high yield bonds while category D indicates the holdings in the share of other split-capital trusts could be even higher.
Jason Hollands, deputy managing director at Bestinvest, said when investors go onto the group's website they can look at a certain zero and get a summary of its underlying portfolio. This, he added, gives them a fuller picture of the zero than they would get by just looking at its published NAV.
The second part of the zero's ranking is its gearing level, which, again, is split into four categories, labelled 1 to 4. If the zero is classed 1 it is up to 10% geared, if it is classed 2 it is 11%-33%, class 3 equals 34%-50% gearing and all zeros with 50% or more gearing are classed as 4.
The zero's hurdle rate evaluation, an indication of the likelihood of its theoretical redemption yield being achieved, is again split into four categories labelled A to D.
Zeros rated A have a hurdle rate of -10% or better, -20% if they have less than three years to redemption. According to BFS, these zeros should be able to withstand a significant drop in market values.
Zeros with a hurdle rate of nil or better, -3% for shorter-dated paper, are classed as B, meaning they should be able to deliver the projected return if markets show no growth. C-rated zeros have hurdle rates of 5% or better, 7% for shorter dated, as they require a reasonable level of market growth. D-rated zeros have 'other' hurdle rates, meaning they require a substantial uplift in market values. The best possible rating a zero can achieve from Bestinvest is A-1-A and the worst is D-4-D.
Hollands said the most attractive zeros are those that currently have positive hurdle rates but still have a reasonable chance of achieving their projected returns on the assumption of modest stock market growth. These are given ratings between A-1-B and B-2-C and yields in this group can be as high as 25% per year.
Hollands said: 'Bestinvest has carried out analysis to compare the potential returns from investing in a UK index tracker with those from zeros where the underlying portfolio consists of the same sort of shares, such as UK blue chips.
'The results show zeros should perform better than the tracker in all scenarios except those in which there is substantial market growth, such as the FTSE 100 hitting 7,000 over the next three years.'
Hollands added there is now a two-tier market in zeros, with the lower-risk zeros and speculative investments. He believes the sharp fall in stock markets, combined with the collapse of some trusts with high levels of gearing and crossholdings, has resulted in a general sell-off in the sector, including higher quality zeros.
Visit www.bestinvest.co.uk/ zeros for a full list of zeros, maturity dates, yields and Bestinvest's new ratings.
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