Within ten days, I count five short-thesis articles about Cornerstone Progressive Return Fund (CFP), written by two authors. I have been very familiar with all the issues raised by these articles for some time. I know of many accredited and institutional Closed-End Fund investors who each have been long familiar with these issues. The temptation to short-sell CFP and other Cornerstone Funds is not new to the last ten days. It appears to me that sometime before noon Wednesday (December 23rd - after five short-themed articles published in less than ten days) the CFP short trade became far too crowded.
To be clear, I am not an advocate of the Cornerstone Funds. I am not recommending purchase of Cornerstone Funds. I have long held respect for Joe Ecqome’s work and applaud the effort and courage shown by both these gentlemen in discussing Cornerstone Funds publicly. I hope their articles will long provide great utility for prospective shareholders. Later in this piece I will provide some of my own observations into matters relevant to the Cornerstone Funds.
To those who have not yet learned the lesson, please realize that short-selling is every bit as dangerous as buying stock at an apparently overvalued price, and then some. You can be fully correct about the fundamentals and long term trajectory of a stock price and you may still lose everything. I was certain as a younger man that Krispy Kreme Doughnuts, Inc (KKD) stock was exceptionally overvalued and that the company’s post-IPO growth was unsustainable. I was very correct but I lost everything shorting the stock before the market came to appreciate my conclusion on its own timeline.
To this day, I have almost no financial assets outside of my IRAs because I lost everything shorting KKD in my (taxable) marginable accounts. I had started by taking only a small position but I failed to realize that shorts including myself were actually contributing to ongoing mispricing. I failed to realize I was in a correct but overcrowded trade. When the market went against me, I failed to temper my trading actions and I magnified my losses. I still have still have tax-loss carry forwards and a miniscule taxable investment account balance to show for it.
There are both near and long term risks to shorting selling CFP that should not be taken lightly. These points are not intended to contradict other authors. My hope is only to provide some additional insights to further consider both sides when anticipating the path of CFP.
Large Shareholders in CFP can more easily engineer a harsh short covering rally than in most other crowded shorts, and they are motivated by both their holdings and their business model to do so.
There are signs to suggest that clients of Doliver Capital may have raised pools of cash by selling into a “take-under” of an alternate fund that inflicted pain on Doliver Clients and associated parties by eliminating its own “ROC” (Return of Capital). That capital pool could easily be used to engineer great financial pain on CFP shorts. Adding insult to injury, such capital deployment could narrowly precede the calling away of stock loans.
When you sell a stock or a Closed-End Fund short, you effectively take loaned shares borrowed from a margin account at any other broker dealer, and sell them. If the long owner which the broker-dealer borrowed shares from on short-sellers’ behalf (most likely a client of Doliver Capital) chooses to change their holding from a "margin" to a "cash basis", the short seller (or their any party responsible for loaned stock availability) can find themselves in position of being a forced buyer. Regardless as to whom the forced buyers are, all short-sellers can suffer the market effect.
There is a selection bias to the shareholder base of CFP, which could potentially lend itself to what in effect is the cornering of a market. The Cornerstone Funds have traded at premiums for years, and the shareholder base has profited handsomely in the process. To the limited extent that shareholders read any of these articles, they still have a natural tendency to continue with the faith in the Funds that has rewarded them for years – particularly with few or no alternate choices of comparable distribution generating options.
Do not fail to read the caveats and disclaimers made by George and Joe in each of their five recent articles. The Investment Company Act of 1940 lays out parameters whereby it is the responsibility of management to serve its shareholders above its management. I am not an advocate of Cornerstone Funds, but I am unaware of any way to argue that Cornerstone Funds have failed in that premise. Every Closed-End Fund Board’s directive is to serve current shareholders, not to create an opportunity for future shareholders to enter at a reasonable price.
In years past there were multiple Closed-End Funds offering similar ROC distributions. Today, there are few similar options to CFP. Further CFP has already announced $0.205 distributions for each of the following three months. The market could assign a further increasing scarcity value for heavy-ROC funds, whether justified or not. I have put tremendous effort into researching why different policies of different funds were affected differently in the last year. I have also spent a great deal of time discussing the issues with regulators. I believe it would be erroneous to assume that fiduciary motivations or being a better citizen lead to changes in the closest peers to the Cornerstone Funds. I speculate that the Cornerstone Distribution Policies will be long-lasting.
When distributions are reinvested they create a significant demand for shares at any market price, and thus provide a repetitive positive force in the supply and demand balance in the market for the stock. The next distribution payable date is December 31, 2009 and distributions reinvested at market are likely to occur on thin trading volume.
Conclusion: Whether we like or dislike the Cornerstone Funds very existence, I would be extremely fearful of speculating on the opposite side of Ron Olin. I have previoiusly researched the origins of Cornerstone Strategic Value Fund (CLM), Cornerstone Total Return Fund (CRF), and CFP beyond the scope of this article. I have no choice but to acknowledge supreme ingenuity along with any other perspectives. Before today, I had never bought a Cornerstone Fund. I don't anticipate making it a habit. I never have and likely never will recommend CFP or any other Cornerstone Fund -- especially not on a long term fundamental basis. Still, it appears a suicidal time to be short because of the overcrowded trade and under-appreciated upside catalysts. For anyone who is inclined to take a short position for the long term despite cautionary reasons toward the contrary, I believe it would be least reckless to initiate positions shortly after distribution payable dates, and then to close out those positions prior to next distribution payable date. I also think it would be wisest to do so when it is an unpopular trade.
Author's Disclosure: Long CFP