Icap AGM on 10th November 2012. Voting for new directors. Are you happy with the share price of your icap? Your destiny is in your hand
Performance of icap NAV Vs KLCI
By 1st November 2012, Icap’s NAV has tripled to RM2.96 since inception on 19th October 2005. For the same period, KLCI has grown by only 84% from 910 to 1676. In compounded annual growth rate, icap’s NAV has grown by a phenomenon rate of 16.8% per year compared to that of 9.1% of KLCI. Only a moron would say Capital Dynamic has not done a good job for icap biz. The question is do investors gain the same magnitude from the market price of icap?
During the bull market at the end of year 2007, icap was traded at a premium above its NAV. The market price of icap reversed to a discount when the sublime crisis struck in 2008. NAV recovered steadily in tandem with KLCI after the low of March 2009 and as at to date, NAV rose to RM2.96 per share. However, the share price did not recover in tandem with the increase in NAV with the discount widening to the highest of 26.7% on 14th June 2012. From then on, the discount closes to 20% on 3rd November 2012 when icap closes at RM2.38.
Icap and the discount puzzle
We will try to examine the possible reasons of the “closed-end fund puzzle” and attempt to fathom if each of the reasons as listed below justifies the big discount of the market price of icap.
1. “Icap is like unit trust; involve high expenses”
The initial cost involved in owning icap is the normal brokerage fees for buying a stock. Its management expense ratio of 1.8% for 2012 is lower than most equity unit trusts funds as icap does not have to pay for marketing and distribution cost. It’s cash drag is lower as cash held is more for waiting for investment opportunity rather than for in case of redemption. Icap’s transaction cost which includes brokerage commissions, market impact cost, and spread cost is lower as its portfolio turnover is low. No additional advisory and soft dollar cost is involved as its fund manager does all their own research.
2. “Like other unit trusts, icap will underperforming the market.”
Since inception on October 2005, icap’s NAV has increased by 200%, or a compounded annual rate (CAR) of 16.8%, almost doubled that of KLCI of 9.1% for the same period.
3. “Icap is illiquid and hard to buy or sell”
With a total market capitalization of only 300 million ringgit. This statement is true. A movement of 5 sen was rarely seen in a day, even a week, or a month; no excitement at all.
4. “Icap does not pay dividend”
Is dividend important for an investor aiming to grow his long-term wealth? Or rather he prefers his dividend to be reinvested in the fund to compound his return? Dividend in Malaysia also subjects to income tax of 25% whereas capital gain is not taxable here.
5. “Icap does not buy back shares when they are undervalued”
That is correct. Which fund managers, or the obedient board of directors nominated or appointed by them will buy back its share and reduce the asset under management, and hence earn less fees?
6. “Icap’s share price depend on demand and supply. Unlike the normal open ended unit trust which buying and selling will be at NAV.” This is true.
It is in fact hearty that there appears to have some shareholder activism with the entrance of a couple of foreign funds owning up to 14% of icap. They have proposed the nomination of 3 directors into the board. If they succeed, what positive actions can they make of which the existing board will not implement to maximize shareholder value? Here are they.
1. Pay a dividend. Receiving dividends seem to be the favourite aim of many investors in Malaysia though in my opinion, it may not be shareholder value maximizing. More investors will invest in this share and boost up its price. A 5% dividend yield will in face yield a 6.2% return because of the discount of 20% of its shares.
2. Implement share buybacks. This boost demand of its shares and increases its NAV.
3. Convert to open-end unit trust. Investors can sell their shares to the fund at NAV, an instant rise of share value by about 24%. There is plenty of cash now in the fund for redemption. If not enough cash, sell assets to raise cash.
4. Liquidate the fund by selling off the shares which would be close to its actual NAV.
Icap has shown that the fund manager has performed very well with an excess return of 7.7% a year for the shareholders against the KLCI. It would be a fantastic and unbelievable feat if they can continue to do so for the next five years. This I highly doubt he can continue to do so. With the deep discount to NAV of 20% for icap price in relation to its NAV, I would say it is a shame that nothing is done about it. With the active participation of the two foreign funds, this may offer a good opportunity for the existing shareholders to exercise their rights in the coming AGM in order to maximize their returns in their investment in icap. One has to think deeply which is more important, royalty to Capital Dynamic or to yourself and your own pocket?
3 comment(s). Last comment by biancheong
at Nov 12, 2012 11:51 PM
Posted by biancheong > Nov 12, 2012 10:54 PM | Report Abuse
It appears that most had agreed with the conclusion by the FM (fund manager) that share buyback is detrimental particularly to the long term benefits of ICAP.biz shareholders.
I would like to offer my 2 cents worth of counter considerations.
1) FM argue that the cash used to buy back shares will deprive shareholders the opportunity to compound that sum of cash at 18% annual rate (ICAP’s average rate of compounding) and that other companies e.g. Berthshire may be ok to buy back as they continue to generate new cash flow whereas ICAP being a closed end fund do not have such new stream of cash. Is this argument correct??
At 18% compound return, $1 will become $2 in 4 years time. So it is true that if RM10M cash is used for share buyback today, the NAV will presumably be smaller by RM20M in 4 years time.
BUT the RM10M cash did not vanished; it is just converted and kept as ICAP treasury shares. In 4 years ICAP NAV/per share double and so we expect its share price will also double assuming the same discount exist then. Should the discount narrowed (in fact most including the PM himself do believe it will narrow or may even become a premium) the price would be more than double. When that happens the treasury shares can be selling back to the market and used for other higher return investment.
So it appears that share buyback at a discount particularly at higher discount than the compounding rate of NAV is a no lose proposition.
More over when the RM140M cash is just earning 1.5% net return( deducting FM's fee of 1.5%)it is not exactly meaningful to assume it can compound at 18% while it is certainly closer to the truth that the ICAP shares bought back will compound at higher rate than 1.5%! and closer to the assumed 18% rate.
As pointed out by Peter Lim the cash used up for share buyback will reduce the NAV by the same amount and hence reduce the FM's fee which appear to be a win loose proposition and if such will not be good for all in the long run. What we want is to ensure alignment of FM and shareholder's interest. But this is only a short term lost to the FM. Longer term when the treasury shares is sold back into more cash the FM will also be rewarded.
Now let us consider share buyback in the case of non closed end fund listed companies e.g. Berthshire. It is true that Berthshire generate plenty of new cash flow yearly while ICAP does not, but it is the same for Berthshire that the cash it used up to buy back its own share will by ICAP's FM same argument also deprive Berthshire's shareholder the opportunity to compound at Berthshire long term rate of ROE(return on equity)
Generate more new cash is not relevant in this consideration. Simply the pertinent consideration is weighing the potential return versus its attendant opportunity cost.
Hence there is really no critical difference in share buyback for close end fund vs. that of non close end fund companies.
Posted by biancheong > Nov 12, 2012 11:11 PM | Report Abuse
Read the edge financial daily interview of TTB on 7 Nov in which he mentioned that ICAP.biz may consider paying dividends if shareholders want it. Why consider paying dividend when he is against share buyback whcih he say will deprive the fund of cash for investment.
Paying dividend will reduce cash for ever while share bought back can be converted back into cash in future.
Can not follow his reasoning??
Posted by biancheong > Nov 12, 2012 11:51 PM | Report Abuse
On 9 Nov Star in an apparent rebukes to Laxey earlier press statements that TTB had overtsated ICAP.biz performance vs that of KLCI benchmark as the index ( used by TTB) was not adjusted for dividend yield.
TTB said: "Despite the fact that the FBM KLCI pays dividend, its performance has lagged that of iCapital.biz, which is a non-dividend paying fund, as can be seen from its first annual report of 2006. If the KLCI pays no dividends, its underperformance would be even worse,”
If TTB uses the KLCI index without adjusting for its dividend he is overstating ICAP.biz performance(against the understated KLCI since KLCI has a dividend yield). If this is not true than he should answer this straight to the point. Instead what he say is rather confusing and misleading.
So let me ask openly here did he used an adjusted(for dividend)KLCI?? If Yes he is not overtstaing ICAP performance if NO he is overstating his performance.