Piet Mouton from PSG Group says the investment holding structure has fallen out of favour locally in South Africa and internationally.
When one looks at the performance of the world’s largest investment holding company, Berkshire Hathaway, it certainly doesn’t seem to be out of favour. Neither does investment holding company Washington H. Soul Pattinson, listed on the ASX in Australia, to give two international examples.
Given that PSG intends to delist, Piet Mouton’s quip provided an excellent quote for the media, but on closer inspection it might not ring as true as it first seems.
The merits of Piet’s comments are moot in any event, given the intention to delist PSG Group. Thus what can the remaining cohort of investment holding companies left on the JSE do to help narrow the substantial and persistent discounts to current net asset value (NAV) and get themselves back in vogue?
I hope to offer some suggestions by taking a few corporate finance strategies from the Listed Investment Company (LIC) sector in Australia and the UK’s Investment Trust (IT) sector.
Discount control policies
Discount control policies, or discount control mechanisms, have come into the UK over the past decade and are starting to emerge as an option in LIC circles in Australia. The basic premise is that the board sets a range of what discount and premium it wishes to target. Generally, the range is from a 5%-10% discount to a 5%-10% premium.
Should the share price start to approach these outer bounds of the range, the board will automatically act either through a buyback on the discount side of the ledger or via share issuance on the premium side of the ledger, until such time the share price is back trading around NAV.
The mere existence of the discount control policy won’t necessarily stop the share price from materially exceeding the limits of the target range on occasion. Still, it signals how the board will respond to dislocations between the NAV and the share price in the future.
Tender offers
Tender offers are a follow-on from discount control policies. Here, boards offer to conduct what could also be called an off-market buyback, but more customarily known as a tender offer in the UK. Shareholders can tender their shares into a facility at a price close to or at NAV generally once a year.
Tender offers are typically limited to a set percentage of the shares on issue, somewhere around 10% of the issued share capital annually. As the tender offer window is approaching under an efficient market, the discount should narrow as market participants seek to accumulate shares they know they can tip into the tender offer at around NAV in the coming weeks or months.
Tender offers can lead to a large overhang of stock being cleared from the market. Tender offers also signal to the market that the board has another option at its disposal to tackle significant discounts to NAV.
Continuation votes
Another common feature of the IT space in the UK – and another emerging trend for more recent LIC initial public offerings (IPOs) in Australia – are predefined continuation votes.
Generally, on a three- to five-year cycle, a resolution is placed on the AGM agenda for the company to be wound up if the majority of shareholders vote for it. Now, trading a significant discount for an extending period before a continuation may cause this to be a foregone conclusion. In many cases, it is, but shareholders have approved the continuation resolution despite significant preceding discounts in numerous other cases. Shareholders passing such continuation resolutions recognise that the current style, strategy, or underlying investments are out of favour in the current market environment.
Shareholders are effectively voting to continue and put their faith in the board and management that they can turn things around. It benefits the board in that it gives shareholders a predefined opportunity. At the same time, if the resolution is passed, it takes the pressure off as shareholders have had their say, at least in the short to medium term.
Internally versus externally managed
We have also had numerous examples where the investment holding company moves to be internally managed rather than externally managed by a management company charging a fee as a percentage of some sort.
Internally managed vehicles see all investment professionals employed by the company. As the business acquires scale, the management costs fall as they are spread over a more significant asset base. Indeed, PSG Group itself is internally managed.
In its last annual report, PSG Group states that the management fee costs equated to 0.51% of its market capitalisation, which is very competitive in the current active management market and compares pretty favourably with a fair majority of passive vehicles.
Tiered-fee structures
When an external manager manages an IT, we often see tiered-fee structures where the management fee rate declines as funds under management increases. By way of example, no fewer than 50 investment trusts have introduced tiered fee structures since 2013, and indeed 39 IT has also scrapped performance fees over this time.
Scottish Mortgage Investment Trust (LSE: SMT), managed by Baillie Gifford, which has £16-billion+ in funds under management, has the following tiered management fee structure of 0.30% on the first £4-billion and 0.25% after that.
SMT has been around since 1909 and has traded at a discount of 0.7% over the past 12 months. Its cumulative total return combining share price and dividends over the previous 10 years is 696% versus its benchmark, the FTSE All-World Index, which has delivered a total return of 220%.
Interestingly, the share price performance has outstripped the NAV performance, which has risen 638% over the past 10 years. Management fees should also be based on market capitalisation and not the NAV. This further incentivises the manager to work with the board to narrow the discount to NAV.
Performance protection
Like all active investment managers, the boards and management of investment holdings companies need to perform in the short, medium and long term. One can’t hark back to the outperformance since inception while underperforming drastically on a three-year or five-year basis. This is where continuation votes can be crucial for shareholders to exit through an orderly windup, or where shareholders can decide to continue with the current strategy.
As a wise old portfolio manager once told me, the easiest way for boards to protect themselves from shareholder unrest and activist investors is to perform. Good performance quells many storms before they even start. However, if the ship has sailed into a storm, perhaps it needs a better captain and crew?
The board must be independent and bold enough to fire the CEO or CIO or replace the investment management company, as the case may be, when they have failed to deliver for shareholders. The IT sector in the UK regularly sees investment managers being replaced.
Board and management ownership
Boards and management should be aligned with the interest of minority shareholders.
If the share is trading at a decent discount to NAV, then insiders and the board should be buying shares on the open market, which is generally taken as a positive signal by the market. There is nothing like showing the market and shareholders that directors and management are willing to spend their own cold hard cash on shares in the open market when a significant discount to NAV arises. As opposed to a corporate level share buyback programme.
The board could also elect to take their directors’ emoluments in shares rather than cash. Accepting shares in place of cash sends another positive signal to the market and minority shareholders regarding alignment. These options also signify validity in the NAV, which can be especially useful when many unlisted assets are part of the NAV.
Silver bullets locked and loaded
None of the above strategies represent a panacea for investment holding companies. Combined, they offer a series of options for boards to consider before jumping to the nuclear option of a delisting.
In South Africa, we routinely see plain vanilla strategies such as share buybacks and asset unbundlings, which don’t seem to have worked to date. At least, not in the case du jour of PSG Group.
We then see boards throwing their hands up in the air and capitulating by announcing the delisting of the listed vehicle. There seems to be relative apathy, it appears to me, from investment holding company boards to tackle these long-standing discounts to NAV more creatively.
Suppose you are a shareholder in PSG Group or any JSE-listed investment holding company – may I suggest you raise these options with the relevant investor relations person or the board at the next AGM and see what response you get? BM/DM