The Cornerstone Funds Are Sucker Bets 10 comments
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Investors are paying $18.50 per share of CRF when it is not worth more than $9.81, its net asset value (“NAV”) per share. Investors in CLM are paying $9.23 when it is not worth more than $5.19 per share.
CRF’s and CLM’s market prices are respectively 88 percent and 77 percent higher than they should be, yet researching these closed end fund’s NAV (their intrinsic values) could not be easier. Just go to Morningstar or ETF Connect and type in the ticker symbols and SHAZAAM! There you have it. Along with a fund’s NAV these websites will display the current market price as well as whether the fund trades at a premium or discount to NAV.
Well, if that’s too much work or if the logic of the argument doesn’t make any sense investors can just read Cornerstone’s own disclosures. On May 18, 2007 Cornerstone’s press release stated:
An investment in a Fund is subject to certain risks, including market risk. In general, shares of closed-end funds often trade at a discount from their net asset value [NAV] and at the time of sale may be trading on the exchange at a price that is more or less than the original purchase price or the net asset value.
In other words, investors have no one to blame but themselves if they purchase shares at a premium to NAV and sell them at a discount to NAV.
Well…is there any reason why investors should believe that Cornerstone’s monthly distributions are adding to their investment results? Again, Cornerstone’s own disclosures should make the situation clear. The May 18, 2007 release states:
A substantial portion of each Fund's distributions made during this current calendar quarter may consist of a return of the investor's capital. Accordingly, these distributions should not be confused with yield or investment return on the Fund's portfolio.
That, however, is exactly what investors are doing. There can be no explanation for this insane market inefficiency other than investor ignorance and confusion. Unfortunately, investors have no one to blame but themselves. Regardless of these significant disclosures, investors have turned a blind eye. Securities laws will not protect investors when they themselves have failed to protect themselves.
In conclusion, I believe that these funds are not ponzi schemes. They are, however, sucker bets.
Disclosure: Author is short CRF
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This article has 10 comments:
not because anything of what the author is wrong, he's head on. But to short this you could be charged a massive "negative rebate fee" by your broker to hold it. Also consider that its in great demand from hedge funds as a short. And the supply of less-liquid desirable shorting shares creates a situation where the big player can trounce the small player because of under-regulation by the SEC. Whenever you short shares they fall under the margin agreement you have signed with the broker. Which means he can call them anytime due to "supply" reasons. So a hedgefund or investment banking arm which is likely a LARGE customer of the brokerage, knowing they can borrow these shares out at 25% per year goes to the brokerage house and says we'd like your supply of CRF and we'll pay you $2 per share more than current market value (which they are happy to since they'll make $5 per share loaning it out over the year). Now the broker calls the little customer on the phone Tuesday and says due to "supply" constraints we are calling your shares by Friday. You'll need to close the position yourself over the next few days or we might do a forced close on Friday. Again, this is not due to insufficient funds in the small guy's account, just a supply call. And the small guy shorted the stock a year ago, paid 12% in dividends along the way, CRF has gone up to a yet larger crazy premium where the small guy has lost more than even the 12% dividends. I've had it happen to me.
This thing has sat up this high for years now, and the large hedge fund holding this long and loaning it out has high confidence they'll keep this thing floating long enough to risk paying the $9 per share premium since they make about $7 per year between the 25% loan-out collect and the dividend collect of $2 per year from the shorter. Not sure how they have this confidence, "special" relationships with other large market participants? Not saying I have any evidence of that. All speculation, because although I don't subscribe to the efficient market theory, this type of imbalance creates heavy curiousity in my mind.
It doesn't seem like the type of "market" the SEC would want... where the little guy this extreme of a disadvantage to the big guy in this playing field. But I guess they might focus on how market mechanics ensure a level playing field on shares held long. The short holding stockholder is perhaps not a great concern, but I do think that is wrong, created by the ability of short "supply" to be bounced around without regulation of free-market price.
Perhaps they have figured out how to make continued high returns on the long side of these two funds, due to the high "negative rebate fee". I wonder what the implications are for the premium to maintain its high levels. If Cornerstone resets the distribution every year at 21% of NAV, and the market continues to price these funds at a "yield" to market price of 12%, perhaps the indicated 75% premium level (21%/12%-1=75%) will go on forever!
Think about it. If the market appreciates 10% a year, the portfolios of CRF and CLM will appreciate about 9% a year after expenses but before distributions. This means their NAV will decline about 12% a year after distributions. Because of the reset, this can be repeated every year indefinitely. All that is required is for the Funds to do reverse stock splits every few years to keep stock price respectable, and to merge in new assets from other captured closed-end funds every few years to keep the Fund sizes and expense ratios reasonable. This has already been done once with the merger of MGC into CLM a couple of years ago.
The "sucker" buying in at the 75% premium and holding forever will realize an ongoing total return of about 5.1% (9%/1.75=5.1%). Since the distributions are dependable and monthly, and classified as either tax deferred return of capital or long term gains, this isn't really terrible in today's world in comparison with fully taxable CD rates. Besides, this "investment illiterate sucker" can kid himself into thinking that he is getting 12% mostly tax free (wrong, but a good cocktail brag!). In reality, this is all just an "annuity" which doesn't compare all that badly with what the insurance industry offers.
Just some food for thought....
The party has to end starting in October when the dividend gets cut. I guess the hedge funds have this on a hair trigger stop loss , and when the end comes , the damage will happen practically overnight. In the meantime, everyone is enjoying the party.
I wrote: "The "sucker" buying in at a 75% premium and holding forever will realize an ongoing return of about 5.1% (9%/1.75=5.1%).
Actually, the math is more complicated, and a 75% premium level is just too high. If the portfolio total return is 9% after expenses, a 23% premium will provide a long term, tax advantaged return of 5.1% . Paying a 75% premium and holding forever results in a 0.0% net long-term return, not 5.1%.
You are nasty
There is certainly a supply demand aspect to it. But there is so much disparity I have to wonder if there is any regulation and/or structure to it.
For a stock like "Travelzoo" lets say where there is a high negative rebate fee and an extremely large short position I imagine the mechanics would be that there are several hedge funds and market specialists competing to offer their long positions to various discount brokerages for a fee they feel would be likely to place their long stock and earn the income from that fee.
But what about these even more thinly traded stocks such as the Cornerstone closed-ends. If rather than many hedge funds and market specialists owning, rather one hedge fund corners the market supply on that stock, a stock which will be in great demand to short due to a crazy premium for a vanilla basket of large cap stocks, can they essentially dictate a charge to the brokerages to be passed on to the customer that shorts? Or might they be well connected to an entity that does set that fee? I know people prefer demand and supply market forces over SEC regulation, but I'd be interested from someone knowing a little bit more about the mechanics here. Is the structure here conducive to supply demand market fundamentals? Any SEC regulations in place for "charges" to lend out stocks?