Page 132 - Profile's Unit Trusts and Collective Investments 2021 issue 2

CHAPTER 7

Preference and Other Shares
When people talk about buying shares, they usually mean the ordinary shares of
listed companies. Ordinary shares, known as common stock in the USA, are the most
popular equities because their rights are simple and clear-cut. But they are not the only
kinds of shares. Preference shares, for example, usually entitle the holder to a prior claim on
dividends (ie, before payment is made on ordinary shares), but often don’t have any voting rights.
Many preference shares effectively pay a fixed rate of interest subject to the profitability of the
company.
Subject to shareholder approval, companies can create different classes of shares with different
dividend rights and different voting rights. Non-voting “ordinary” shares (called N-shares) were
popular on the JSE in the 1980s because they allowed controlling shareholders to raise capital
without the risk of losing control of the company. They have the same ownership and dividend rights

Equity-based investments reward investors in two ways: they offer capital gains as the share
price increases, and they offer dividends, which is the portion of profits that a company chooses to
pay to shareholders.
Underlying Investments of Equity-Based Schemes
The bulk of equity investments held in South African collective investment schemes are
ordinary shares listed on the JSE and some overseas stock exchanges. Ordinary shares represent
ownership in a limited liability company, entitling shareholders to dividends paid by the company.
Usually, each ordinary share carries a single vote. Shareholders appoint company directors at an
annual general meeting, and the directors of large companies act (or are meant to act) in the
interests of shareholders.
Shares are such popular securities around the world becausetheygiveinvestors asimplemethodof
participating in the wealth-generating potential of big businesses. A shareholder is part-owner of a
business, no matter how small his stake, and he ultimately shares in the profits of the business.
Growing companies offer profit potential unequalled in other areas of investment. There are
many examples of shares that have grown tenfold in a decade, and many listed companies can
sustain growth rates of 30% p.a. or more under the right economic conditions. It is these
outstanding returns that maintain investor interest in equities.
Unfortunately, businesses are complex, and predicting which companies will make big profits
and keep growing is notoriously difficult. When it comes to equity markets, there is also the very real
risk of investing in a business which goes bankrupt, leaving shareholders with nothing. It is this high
risk/high return character of equity markets which makes them so volatile and unpredictable.
It is the riskiness of individual shares which makes the principle of diversification so important for
stock portfolios. Collective investments which hold broad-based portfolios are therefore an ideal way
for smaller investors to achieve adequate diversification across equity sectors.
Equity markets are influenced by the business cycle, although stocks often lead economic trends,
recovering ahead of the economy at the end of a
recession, and peaking before the economy
during periods of economic growth. Stock
markets are also prone to “herd” behaviour, one
of the factors giving rise to sustained bull and
bear markets. In simplistic terms, market
optimism tends to carry all shares higher, and
pessimism tends to drive all shares lower,
downplaying the riskiness of shares when times
are good and overemphasizing the negatives
when times are bad. It is the tendency of equity
investors to cyclically overvalue and undervalue
stocks that necessitates long-term positions in
order to reap the benefits of equity markets.

130 Profile’s Unit Trusts & Collective Investments — Understanding Unit Trusts