'Pull to redemption' tantalises as fund yield hits 9.2 per cent

According to Peter Hewitt, manager of the F&C Progressive Growth Fund, Gross Redemption yields on high quality zero dividend preference shares have hit levels not seen since August 2004 but with significantly better levels of security.

Hewitt's cautious fund targets a combination of the most secure 'zeros' – a class of share historically issued by some investment trusts which aim to pay investors a fixed price at a pre-determined maturity date, providing the trust's assets are sufficient – as well as 'synthetic' instruments which similarly seek to offer investors a predictable future return. Unlike some other funds operating in the 'zero' market, Hewitt avoids more speculative issues where the assets of the underlying investment trust must grow before the return to zero holders is covered.

"As the share price of the F&C Progressive Growth Fund has tracked sideways over the last year, the Gross Redemption Yield – which is indicative of future returns – has increased to the highest level for three years, 9.2%. This is of course incredibly attractive compared to fixed income yields," explained Hewitt."The last time the yield was this high was August 2004 but thereafter the similarities between then and now end."

Hewitt argues that the key difference in the market lies in the financial security of the underlying holdings in his portfolio which is best illustrated by the level of asset cover. This key ratio measures whether there are enough assets today to repay the wind up value of the zeros, after charges, on maturity. For example, asset cover of 1.5x would imply that 33% more assets exist than are required to meet the final maturity value of a zero. So shareholders in the zero could stomach a significant reduction in the market value of the underlying portfolio before their expected payout is threatened.

"Back in August 2004 the average asset cover on the Progressive Growth Fund was 1.14x but it is now 1.60x. Quite simply this means the asset cover of the portfolio has never been stronger, despite the mouth-watering Gross Redemption Yield," said Hewitt. He also notes that in the twelve months following the previous yield peak in August 2004 the fund's share price rose by 13%. "I believe that the flat share price on the Fund over the last year represents performance deferred rather than performance foregone. The key thing here is the 'pull to redemption'. The longer the current share price of a well covered zero fails to move towards its wind up price, the shorter the time period remains for the return to be reflected. This is why I believe there is a real opportunity available."
"Remember the pull to redemption," concluded Hewitt.