Overview
If you’ve heard of one hedge fund manager from the
last ten years there is a good chance it’s Michael Burry. The eccentric investor
made millions on his bets against the housing market during the Global
Financial Crisis and was immortalized in the book and later film The Big Short. What is less well
remembered about Burry’s story is that before the housing market blew up
countless panicked investors withdrew their money from his fund, worried by
Burry gambling so much money betting against a housing market in the middle of a
boom. While Burry still made millions from his bet, it was less than it could
have been, and the stress and frustration of the whole process led to him
deciding to close his hedge fund.
Burry’s story highlights a fundamental issue with
hedge funds: investors in hedge funds can withdraw their money whenever they
like. It is often precisely when a hedge fund manager sees the most
opportunity, for instance when the market is falling or in Burry’s case when a
bubble is about to burst, that investors want their money back.
It is for this reason amongst others that Listed
Investment Companies (LICs) have gained in popularity in Australia over the
last decade or so. LICs are basically a hedge fund or managed portfolio that is
publicly traded on the ASX. Unlike a hedge fund though, when investors decide
to they want their money back from an LIC they simply sell their shares, which doesn’t
reduce the money available to the manager of the LIC. This means that LIC
managers are less beholden to their investors, and, the theory goes, therefore
more able to concentrate on maximising returns.
The Fat Prophets Global Contrarian fund is the
latest such LIC to list on the ASX, with their 33 million dollar IPO at $1.10 a
share expected to close on the 10th of March. Fat Prophets was
started in the year 2000 by their founder Angus Geddes as a subscription based investment
advice and funds management company. Investors who sign up to their service are
given access to a daily newsletter, as well as reports on certain stocks with buy
and sell recommendations. Since inception the organisation has grown to over 75
employees and 25,000 subscribers, and now provides stock picks for a range of
different markets and sectors. The Fat Prophets Global Contrarian fund is the
first time Fat Prophets has branched out into the LIC world, and it will be run
by Angus Geddes and his team using the same contrarian investing principals
that has made Fat Prophets a success.
Pros
The Fat Prophets track record
Fat Prophets impressive growth over the last 16
years has been largely due to a record of stock picks which would be the envy
of most fund managers. Since their inception in 2000 until the end of 2016, the
annual return of an investor who followed all their Australian equities stock
tips would have been 18.49%, against an All Ordinaries return of only 7.96%.
They have had similarly impressive success in their other sectors. On the Fat
Prophets website all of their past stock tips from 2006 to 2016 are publicly available, and reading these you get a good sense of the company and how they
have achieved this level of success.
Each stock tip is thoughtfully written, with
impressive amounts of detail about each company and its market outlook. If you want to gain an understanding of their
investing rationale and style, have a look at their buy recommendation for
Qantas shares in August 2014.
The post goes to painstaking lengths to break down
Qantas’s market position, their recent challenges, and why the Fat Prophets
team felt the struggling airline could turn things around. Not only did the
recommendation prove to be spot on, with the share price more than doubling
over the next twelve months, but they were even correct about how it happened. They correctly
predicted that a decrease in flight volumes along with the cost savings of Alan
Joyce’s restructures would help bring the company back into profitability. Of
course, not all their recommendations ended up being as spectacular as this one,
but in all their tips they display a similar level of knowledge, discipline and
intelligence. The opportunity of being able to get in on the ground floor with
a team like this as they embark on a new venture is definitely an appealing
prospect.
Minimal Restrictions
Reading through the prospectus, one of the things
that jumps out at you is the loose rein Angus Geddes has given himself. While
most LICs typically restrict themselves to certain sectors, areas or assets
types, the prospectus makes it clear that Angus Geddes and his team are going
to invest in whatever they feel like. They reserve the right to trade in everything
from equities to derivatives, debt products and foreign currencies, and to go
from 100% cash holdings all the way to 250% leverage. While some might see this
as a risk, to me this makes a lot of sense. If you believe that Geddes and his
team are worth the roughly $400,000 annual fees plus bonuses they are charging
to run the fund, it makes little sense to restrict them to a sector or
investment type. With this level of freedom, Geddes can go after whatever he
feels will give the most value, and there will be no excuses should the fund
not perform.
Cons
Listing price
As a new entrant with a smaller Market Capitalisation
than the established LICS, fees are inevitably higher than some of the more
established listed investment companies. The Fat Prophets Global Contrarian Fund
will charge 1.25% per annum of their net assets in fees. In addition, a
quarterly bonus will be paid each time the portfolio ends a quarter on a historical
high of 20% of the difference between the current portfolio value and the next
highest historical portfolio value. By contrast, Argo and AFIC, two of the
largest Australian Listed Investment Companies charge fees of under 0.2% of
their net assets per annum. It should be pointed out though that both Argo and
AFIC regularly underperform their benchmark indexes, so perhaps in the LIC
world you get what you pay for.
Net Tangible Assets
After the costs of the offer are paid for, the Net
Tangible Assets of the Fat Prophets Global Contrarian Fund based on a maximum
subscription will be somewhere around $1.08 per share. Listed Investment
Companies usually trade at a relatively small discount to the net value of
their portfolio, as the market prices in the fees an LIC charge. This means we
can assume the shares actual market value will be somewhere around $1.05 to
$1.07 after listing, versus a purchase price of $1.10. While this is the same
for every newly listed LIC, it does mean that any investor thinking of
participating in this offering needs to be in it for the long haul, as there is
a good chance the shares will likely trade at below listing price for at least
the first couple of months.
Wildcard
Loyalty options
Every investor who participates in the Fat Prophets
IPO is issued with a loyalty option for each share purchased. From 12 to 18
months after the listing date, shareholders will have the option to buy an
extra share in Fat Prophets for $1.10 for each share they own, regardless of
what the actual stock price is. These loyalty options are forfeited if an
investor sells their shares in the first year and are not transferred to the
new owner. Initially this seems like a great deal, as you can double your
holding at the listing price if the fund performs well, however the fact that
everyone participating in the IPO is issued with the same loyalty options
negates most of the benefit. In fact, in a simplified world where the stock
price equals the net assets and no one sells their shares in the first 12
months, the loyalty option provides no benefit at all.
To understand this, imagine that based on these
assumptions the shares are trading at $2.20 after 12 months. Initially you
might say the loyalty options now give each shareholder a bonus of $1.10 per
share, as they could buy shares for $1.10 then immediately sell them for $2.20.
However, this overlooks the fact that every other investor would also be
exercising their options, doubling the number of shares on offer. At the same
time, the company assets would only increase by a third from the sale of the
loyalty options, from $66 to $99 million. With $99 million of net assets and
now 60 million shares on issue, the share price would now be $99,000,000/$60,000,000
= $1.65. This means that not only would shareholders only make 55 cents per
loyalty option, their original shares would have also lost 55 cents in value at
the same time, giving a net benefit of zero for the option.
Of course, the real world never plays out like the
textbook. Some shares will inevitably change hands in the first 12 months, reducing
the number of options available and therefore providing some value to those who
still have their loyalty options. However, any investor thinking of
participating in this offering should make sure they have the funds available
to exercise their options after 12 months if the share price is trading above
$1.10, as otherwise they risk seeing the value of their shares reduced by other
investors cashing in their options without being able to benefit themselves.
Summary
If you are looking to for an IPO that is going to
double your money in six months, this isn’t the one for you. Any gains here are
likely to be in the long term. Nor is this an IPO in which to invest your life
savings, as the freedom Geddes and his team have given themselves mean that the
risks could be considerable. However, if you are looking for a good long term
investment opportunity for a portion of your portfolio, investing in this IPO
could make a lot of sense. The Fat Prophets team have proven they know what
they are talking about when it comes to investing, and if they can get anywhere
close to their previous success the fund will do very well.
Personally, Geddes track record is too good to pass up, and I will be making a small investment.
Personally, Geddes track record is too good to pass up, and I will be making a small investment.
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