While our methodology recognizes that there is no change in the total value of the Company, from the stockholder's perspective, he has received 20% more shares (.133 -. 111/ .111) by reinvesting at the market price, which is a direct result of the Company's discount. Our methodology reflects this economic benefit that is actually earned by the shareholder.
"Great minds think alike -- and fools seldom differ." Further proof of this adage came shortly after we reviewed the proxy fight now winding to a close at Adams Express (NYSE:ADX), where the Gramercy hedge fund group wants a major stock buyback near net asset value, while the management has dragged its heels on doing anything about the persistent double-digit gap between ADX's share price and the net value of its portfolio assets.
That earlier article suggested that ADX was basically just "old and in the way" -- a closet S&P 500 index fund, only not as good -- and that its reported portfolio performance had been goosed up by an accounting gimmick: Treating distributions as though reinvested in shares using the discounted market price, but switching to the higher net asset value when calculating what such shares would potentially be worth at year end.
One week later we were pleasantly surprised to learn that our analysis echoed that of Dr. Tony Tessitore, whose academic expertise in closed-end fund finance now sees action as a Gramercy portfolio manager. In a letter sent to ADX and the SEC in February, though not released to the press until March 7, he patiently explained why mixing market prices and asset values, as ADX had done, could grossly exaggerate reported performance.
Squawk! The ADX folks hurried to concoct a response, which they plopped onto the SEC's EDGAR website as DEFA14A on March 17, just five days before the shareholder meeting. As an exercise in obfuscation it's predictably mediocre: In effect agreeing that Dr. Tessitore would be right if the fund company simply distributed cash, but raising as a defense ADX's practice of issuing new shares at market, below asset value, to those holders who elect stock instead of cash. Two wrongs, they claim, make a right: The loss from involuntary dilution balances the overstated gain from switching reinvestment values.
In 2010, about a third of ADX's distributions were reinvested. (So Dr. Tessitore is at least two-thirds right.) The fund issued 1,455,912 new shares at roughly 85% of asset value ... a bargain coming at the expense of everyone who already owned ADX and had the asset value backing their shares eroded. To the folks running ADX, this is a good thing. To quote spokesman Lawrence Hooper, Jr:
Huh? Sure, everyone has 20% more pieces of imaginary paper called "shares," but the value of the underlying portfolio they represent hasn't changed at all. What sort of "economic benefit" is that? It takes money, not ADX stock, to buy groceries, and you can't eat ADX share certificates (they're too tough and stringy). The ADX managers, like many others in the closed-end world, seem to value the welfare of abstract entities, of incorporated portfolios, above that of their fellow human beings.
Indeed, they are so intent on justifying themselves that they overlook an elementary error in their calculated example, which starts by assuming an x-div market price of $7.50 and NAV of $9.00, proceeds to calculate a diluted NAV of $8.8236, but fails to re-adjust the market price to reflect the new, lower, NAV.
ADX will probably survive Gramercy's challenge this year. But the fund's individual shareholder base -- the sort who are susceptible to appeals to misty (or musty) tradition -- is aging, and as it departs, it is replaced by cool, rational institutions and hedge funds. ADX is running scared because its business model is fundamentally obsolete. Its owners would be better off if it ceased to exist.
Disclosure: I am long ADX.