When an established company issues equity shares and convertible debentures to the public at large, the issue price is likely to be set in such a manner that it represents a discount over the prevailing market price. Hence, such issues may represent an attractive investment opportunity for investors. Obviously when such issues are very attractive, they are heavily over subscribed. As a result, the chances of allotment and hence expected gains diminish. Yet, such issues should not normally be missed by investors who are looking for opportunities in the stock market.
Rights Issues of Equity Shares and Convertible Debentures of Established Companies:
When a company issues additional equity capital, it has to be offered in the first instance to the existing shareholders on a pro rata basis. This is required under Section 81 of the companies Act, 1950 (the shareholders, however, may forfeit this right by passing a special resolution)
Theoretically, the market value of a right is equal to:
Expected market price per share after the rights issue – Subscription price per share
For example if the expected market price after the rights issue is Rs 30 and the subscription price per rights share is Rs 20 the market value of a right theoretically will be Rs 10. Hence, the wealth of a shareholder remains unaffected whether he exercises his rights or sells them. In practice, however, the market value of a right is usually less than its theoretical value. So, the investor who sells his rights tends to lose. Hence, as a shareholder, you should exercise your rights in full and also, whenever possible buy additional rights in the market place.
Switching: If you are a shareholder of a company which is making a public issue and / or rights issue of equity shares or convertible debentures it may be advisable to sell your equity shares just when they become ex-rights and subscribe to the new issue. Put differently, it may be profitable to switch from the old shares to the new shares. Why is such a switching strategy recommended? Due to imperfections and/or interventions in the stock market, the price decline which ought to occur instantaneously on the day the share becomes ex-rights tends to take place over a period of time.
Participate in the Schemes of Mutual Funds:
Apart from the Unit Trust of India which was set up in 1964, a number of mutual funds have been set up in recent year. In addition to a number debt oriented schemes, these mutual funds have floated equity oriented schemes meant for investors who want to have a share in a broadly diversified equity portfolio.
In general, these schemes are good vehicles for participating in the market. The primary reason is that investing in equity can be very demanding for an individual investor. It requires a lot of time, attention, and effort to gather and process information. In order for it to work, it really has to be an avocation like playing tennis or stamp collection. It’s something that is going to consume a lot of your free time. You’ve got to like it.
If you have neither the time nor the inclination to manage your portfolio of equity shares, you will find the schemes of mutual funds very convenient. The general advantages of such schemes are:
1. Benefit of diversification
2. Tax shelter
3. Professional management
4. High liquidity
5. Minimal paper work
Given the dynamic changes in the world of investments, most individual investors may find it difficult to manage their equity investments. So they would do well to invest a substantial portion of the stock component of their portfolio in equity oriented mutual fund schemes. Here the most favorable option for a conservation investor may be an index scheme which purses a passive strategy and entails a lower management fees. Another attractive option is a close end mutual fund scheme selling at a tempting discount over its NAV. —