Cornerstone Funds Alters Dividend Reinvestment Policy - No More NAV

While conducting research on the Cornerstone Funds earlier this year, I came across George Spritzer’s article dated Feb 20, 2007. He discusses the mysterious NAV premiums of two Cornerstone funds: Cornerstone Total Return Fund (CRF) and Cornerstone Strategic Value Fund (CLM).

It is not atypical for funds to trade at slight premiums or discounts to NAV (strength of management, liquidity issues, international positions, etc.). This being said, nothing seems to justify the 90% premium to NAV for a manager whose top holdings basically mirror the Dow. In his article, Mr. Spritzer asks “If any of my readers have any ideas as to why Renaissance may be holding these two fund positions I would love to hear them.” I have a possible explanation as to why a firm would be long these two funds.

Up until a few months ago, any investor (including insiders) that owned these two funds and opted for the dividend reinvestment policy (as opposed to cash) was receiving its new shares at net asset value upon distribution. Considering the premiums both of these funds traded to NAV, one could sell these new shares in the market at a huge profit. It appears that Renaissance also figured out this loophole. My suspicion is that their position was possibly “boxed” both long and short; they were paying the dividend in cash on their short and collecting the dividend on their long via highly discounted shares – essentially a riskless trade. As George Spritzer mentioned in his article, Renaissance does not have to disclose short positions in their SEC filings.

Why am I writing a post exposing this fantastic inefficiency? It’s simple: the game has come to an abrupt end. As per the fund’s most recent 10-K filing, Cornerstone altered their dividend reinvestment policy and no longer issues shares at NAV. Perhaps Cornerstone sensed regulatory heat… maybe they felt the trade was too crowded and needed to pause for a few months.

Disclosure: The firm with which the Author is affiliated is short CRF

Comments

[grinninbrit:]

First of all thanks for your opinion on the Renaissance Strategy. But I can't necessarily concur that there was only that element to their strategy. The one other thing I disagree with is your comment "Why am I writing a post exposing this fantastic inefficiency? It’s simple: the game has come to an abrupt end. "

I should also say I have a short position in this and find the valuation here not merely ridiculous, but sure to be a element of some future financial thesis on the breakdown of efficient market theory as we know it...

That being said, the Renaissance team is far more intelligent than I. And years ago when you or I might have also suspected an "abrupt end" to this, they were far more right than us. They've milked this extraordinarly well. And I suspect not just for the dividends, even distributed at NAV. If your them, you don't pick up a vanilla large-cap closed end at 70-100% premiums for that little game.

They have another edge.

Most investors here are either not getting this stock short or paying 25-50%+ negative rebate fee's to their broker for the supply of this to short. My guess is that Renaissance corners the market on this security, and although your broker is getting a little piece of that 25-50, Renaissance or a "partner" collects the rest for providing supply to the brokerages. This is a guess. I need more education on how negative rebate fee's are determined and distributed once collected from the margin accounts holding the shorts.

But even if I'm completely wrong I believe there is another missing piece to this puzzle that is far more complex than we can know. You are correct that its certainly got nothing to do with the value of the fund or its holdings. Crazy, crazy, valuation. But I'll bet Renaissance has some type of "edge" here that the rest of the "public" market is not privy to. And they'll have it as long at they need or want to have it. An abrubt end should not be assumed.

2007 Jul 05 02:47 AM

[grinninbrit:]

today on July 9th was that Renaissance or someone else that had 450,000.00 dollars to spend at 10:35AM CDT and decided that the best way to invest that money in this market was to split it down the middle with almost a quarter of a million going to buy CRF and almost a quarter of a million going to buy the other Cornerstone fund CLM. One at 10:35am and the other ticking off at 10:39am. Then it must have been off to a Wall Street lunch after a morning of hard work investing another half a million in funds trading 75-100% premium... anyone have any clue what kind of edge they have secured ?

2007 Jul 09 06:07 PM