When the recent bout of risk aversion sent many investors fleeing the Hong Kong stock market, Yang Liu, a long-time fund manager of Chinese equities, did exactly the opposite.
Ms Liu, chairman of Atlantis Investment Management, which has $2bn invested in Chinese stocks, says: “I am a complete bull on Chinese equities, there is nowhere for the market to go but up from here.” But she did not add to her existing holding of shares in China Life, the company she believed would rebound sharply.
Instead, she scooped up the company’s warrants – a kind of derivative that amplifies the effect of a rising share price. Last week, China Life’s share price rose 11 per cent to HK$21.50 ($2.75). However, the warrants – 10 of which give the right to buy a China Life share for HK$22.688 in November 2007 – jumped by 50 per cent to HK$0.21 over the same period, so she took her profits.
Ms Liu is just one of many investors in Hong Kong and China buying warrants, which are exchange-listed and can be bought and sold just like shares. Warrants have long been popular in many developed markets, particularly in Europe. But they are taking on a new prominence in Asia, particularly in Hong Kong and China, where frenetic speculative activity by mostly retail investors has fuelled an explosion in warrant trading.
Investment banks hold regular seminars and teach-ins for the general public, while financial newspapers and radios run advertisements on warrants.
“We have at least three seminars a week on warrants for retail investors,” says Edmond Lee, senior vice-president of equity derivatives at Société Générale.
“Over the past few years, warrant issuers have been putting a lot of effort into marketing and education about risk and return.”
Like options, warrants allow investors the right – but not the obligation – to buy a security at a future time for a fixed price.
They allow investors to gain leveraged exposure to shares and share indices at a fraction of the cost of share.
Unlike call options, warrants are issued by a financial institution (covered warrants) or a company attempting to raise capital (company-issued warrants) whereas options are exchange instruments, which are not issued by a company or financial institution but are negotiable contracts with standardised terms.
Also, the life of a warrant is often measured in years, and that of a typical option in months.
Michael Walker, director of Asia Pacific equity derivatives and head of Asia Pacific warrants at Citigroup, says: “The chief driver of the market is speculation and more than any other region, people in Asia have more of a desire to speculate on the stock market.” He adds that warrants accounted for more than a quarter of Hong Kong market turnover last year.
Gary Suen, director in global market equities at Deutsche Bank, says: “In Hong Kong, the majority of warrants investors are retail. There are also professional investors, including hedge funds, but they use over-the-counter products versus exchange-listed warrants in order to execute larger trades.”
But China – which saw its first warrants issues on the Shanghai and Shenzhen stock exchange only 18 months ago – has already overtaken Hong Kong as the largest warrants market in the world in terms of turnover.
Hong Kong, where interest in the H-shares of offshore Chinese companies listed in HK has driven activity, is the second-largest market.
According to the latest data compiled by Goldman Sachs, total warrant turnover in China’s stock exchanges was $250.5bn in 2006, compared with $230.4bn in Hong Kong and $124.3bn in Germany. In January this year, warrant turnover in China was already nearly $40bn and in Hong Kong about $34bn.
This is with only about 26 mainland Chinese warrants trading, compared with over 2,000 on the Hong Kong Exchange and more than 170,000 listed securitised derivatives products available in Europe, according to Cheril Lee, executive director and head of securitised derivatives products at Goldman Sachs in Hong Kong.
Part of the growth in China is also due to a lack of other derivatives available to investors. “They don’t have a lot of deriviatives products to trade,” says Ms Lee. She adds that warrants appeal to investors because they are easy to understand. “The demand is there for simple products.”
Warrants are becoming increasingly popular in other Asian markets, including South Korea and Singapore, while bankers say there is potential for growth in Taiwan. However, there are differences across markets.
In mainland China, for instance, warrants are only issued by listed companies predominantly for capital management purposes to issue new shares.
Mr Walker of Citigroup says: “There is not a traditional bank-issued covered warrants market in China like we see in Hong Kong, Singapore or the rest of the world but there is a huge appetite in that market for this type of product.”
Volatility in Asia stock markets is unlikely to stem investors’ appetite for warrants, bankers say. However, they also point out that warrant issuance is linked to strong markets. In the late 1980s, for example, Japanese borrowers, taking advantage of the strong market, issued a lot of bonds with very low coupons, with warrants attached.
When the stock market crashed in the early 1990s, the warrants – which were separated and traded separately – expired worthless.
“It’s not coincidence that they took off so strongly since 2002,” says William Lee, head of equity derivatives Asia Ex-Japan at JPMorgan. “The warrant is a bull market instrument.”
