Special Situations, CEFs
Contributor Since 2017
The great reputation and trust many have in Argo made it quite easy for them to raise plenty of funds for ALI. Perhaps many wouldn’t have even closely examined the fee structure? It was done at an opportune time with the Listed Investment Company (LIC) market having recovered to be very buoyant. Many private investors were searching for offshore exposure to help with diversification. It provides Argo with a steady amount of management fees, with perhaps not a huge amount of ongoing effort required. Yet does it offer the investor who participated in the IPO anything special?
Whilst I don’t mind seeing no performance fees, the base management fee is 1.2%. They are certainly not the most expensive in the market, but what I found unusual was the breakdown of such fees.
WHERE DO THE FEES GO?
From my understanding, the “portfolio manager” is Cohen & Steers Capital Management. The “manager” in this case is Argo. Argo appoint Cohen & Steers, who make the investments of the portfolio and advise Argo of how things are going.
Cohen & Steers and Argo share the fees that come out of the company on a 50/50 basis. Sound fair?
In fairness I think it may not be that easy for us small Australian investors to access Cohen & Steers funds at better than the 1.2% fee. I believe though that a similar Closed End Fund exists on an offshore exchange. (UTF) looks to have a very similar portfolio, but with some modest in-built leverage. I have no objective with Argo getting an ongoing slice of fees, even if it shouldn’t take an excessive amount of work for them once it is up and running. I just have some doubts whether taking half leaves enough room for the end investors in ALI to get a good result overall.
WHAT DO ARGO DO?
Argo have appointed the portfolio manager being Cohen & Steers. Argo will have to monitor and supervise how C&S are going as portfolio managers on behalf of shareholders, and decide whether this relationship is best to be continued with in the future. Argo manage the general affairs of the company, and administration etc.
The Argo brand is renowned for lean fees, so I was surprised to see the name being put to a product where the fee structure is of this nature.
DISCOUNT TO NAV BUT HOW MANY SHARES HAVE BEEN BOUGHT BACK?
A modest buyback has recently been announced, 5% where often 10% is used by other companies.
Is it the buyback you just announce, even when you don't really want to do a buyback? As I write I am yet to see any shares being bought back.
A LARGE DISCOUNT TO NAV, AN OPPORTUNITY FOR MANAGEMENT TO PUT MORE SKIN IN THE GAME?
In the last Annual Report, I only saw director’s holdings in the stock that I struggle to describe as more than “modest” exposures. At the time of writing I have only just very recently noticed them buying more. This is mildly encouraging but the purchases are not huge. For this type of LIC structure I was surprised to see the amounts of director’s fees in total that were paid. I can recall the company remarking that the discount to NAV represents an attractive way to invest in ALI for other investors, but how about themselves?
The other Argo LIC (ASX code ARG) has a large stake in ALI already, but not so large from the perspective of the overall fund size of ARG. Is the stake held because they are true believers in ALI, or for other reasons?
PERFORMANCE AS A LIC
Looking at the latest monthly report at the time of writing, it shows performance of 4.9% per annum versus their benchmark at 8.3% per annum.
LONGER TERM PERFORMANCE
In fairness to the product, I fully accept that the record as a LIC is too short to make too many judgements regarding the investing performance of the portfolio. From what I have read, I do regard C&S as quite a capable manager in this specialized space. There appears to be enough historical evidence that C&S can add alpha within their categories even after fees. Of course, we can’t be sure of this continuing in the future. History can be a useful guide, but achieving out performance as an investor in ALI would be easier without Argo receiving the extent of fees they do. It doesn’t appear to me that C&S are hugely active investors, so I am also a little sceptical regarding fees in the context of their bets versus the benchmark.
WHY WOULD I OWN THE STOCK THEN?
Well these types of discounts to NAV are rare these days, and were it to widen I suspect eventually the modest share buyback will provide a little bit of support.
I also watch as an outsider in the situation going on with (ASX code WDE), where renowned activist Wilson Asset Management (ASX code WAM) bought a substantial stake. Only AFTER this occurred, the fund manager that runs it in Perennial were seen increasing their stake. This caused some competitive buying that has reduced the discount to NAV. Could there be some parallels to the situation with ALI? Will we see fund manager ARG need to lift their stake and protect their product? As I write there is not a known activist with a substantial stake in ALI. Yet with the IMA as it is, a large discount, a liquid portfolio, I could see the temptations from some to get involved.
I have observed a closed end fund from Cohen & Steers that looks quite like ALI (UTF), which normally trades at under a 10% discount and the expense ratios do not look much different. If this is correct than ALI shares (when they traded at a 15% discount to NTA where I estimated I purchased) may stack up ok on a relative comparison.
What is far more important of course is ultimately where the NAV goes from here. This sector has been very boring as the global bull market has been in full swing this year, meaning it is one of the few relatively depressed areas. If the global economy does suffer some unexpected jitters, it wouldn’t shock me to see a few tailwinds for the ALI portfolio. That may consist of a falling AUD/USD, falling bond yields, and a pickup in relative demand for perceived defensive stocks.
In some of the quarterly commentaries I have observed the lacklustre oil price has been a bit of a headwind for some of their stock exposures. I don’t mind an investment where an improvement in oil prices may act as a small tailwind.
If I am wrong on the above, then it is possible the unusual structure of ALI may not be that sustainable. I am not convinced Argo can necessarily keep the IMA structure the same in the medium term to longer term, if other shareholders are frustrated with the performance. Large cuts to either the fees Argo get, or C&S or both may deliver a product that can better deliver good results for shareholders. If that doesn’t reduce the discount to NAV, a sizeable off market share buyback could be used. The LIC would still have the scale to cope with admin costs even if it is smaller. If no action to reduce the discount to NAV is taken by management then the future of the structure could be in doubt, as the holdings wouldn't be too difficult to liquidate.
Common sense would hopefully see Argo address some of the issues themselves, but common sense is not so common these days. Sometimes management are slow to act and leave it to others. I have been encouraged by some in the investment management industry who have taken the initiative to cut their own management fee income in recent times.
C&S look like a capable manager but having a somewhat lean run, they could easily turn things around in my opinion. If there is not much change to the overall structure of ALI, although I don’t agree with the high fees, it can still be an acceptable investment. The fees are at a level that I can still tolerate when entering at a discount to NAV of about 15%.
Disclosure: I am/we are long ALI.AX.
Additional disclosure: Not licensed to give financial advice or aware of your personal circumstances so please do your own research.