What are Wilson Asset Management's intentions for the CD Funds?
Summary: On 9 June 2023, a Wilson Asset Management fund - WAM Strategic Value - posted a media release advising it is voting No to the proposal for KAM to take over as responsible entity of the CD Funds. WAR disclosed it owned CD1, CD2 and CD3 and wants divestment and return of capital expedited. In this post, I provide further details of WAR's CD Fund holdings and discuss WAM's options and possible intentions regarding the CD Funds.
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| If WAM is playing chess; who is playing checkers? |
Details:
> Voting advice on KAM taking over as responsible entity
> AFR: Geoff Wilson enters Cordish Dixon PE funds fracas, motives unclear
- Excerpt text further below
> Samuel Terry to reject URF appointment of K2
Note: K2 Asset Management (KAM) was voted in as responsible entity for all three listed CD Funds on 19 June 2023. Hence, future actions discussed below, relating to the responsible entity function, are not likely.
1. Since 30 June 2022 WAR has been building holdings in CD1, CD2 & CD3. As of 31 May 2023, CD2 and CD3 are Top 20 positions
- According to the FY2022 AR, as of 30 June 2022, WAR held no shares in CD1, CD2 or CD3.
- In the WAR April 2023 Investment Update CD3 appeared as a Top 20 holding for the first time.
- In the WAR May 2023 Investment Update CD2 and CD3 appear as Top 20 holdings.
- The positions are small but as of 31 May 2023 WAR is 27% cash ($56m).
- Liquidity at market prices (20-30% discounts to NTA) in the CD Funds is low so it can take time to accumulate any significant position without significantly closing the discount one gets.
2. Could WAR ultimately merge with one or more of the CD Funds?
WAR has held cash weightings of 25-40% since inception which is a huge cash drag given there are almost always deeply discounted LICs and LITs to consider. I suspect part of the rationale is that it was originally envisaged that opportunistic short-term trades or scrip-for-scrip mergers might be undertaken, with significant positions having to be built relatively quickly. The FY2022 AR stated:
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"WAM Strategic Value’s flexible cash position enables us to continue to take advantage of market mispricing opportunities, including securities trading at discounts to assets or net tangible assets, corporate transactions and dividend yield arbitrages in the current market environment. As at 30 June 2022, the Company’s investment portfolio held 40% in cash."
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Now that WAR has traded at a persistent discount for awhile, scrip-for-scrip mergers are less likely, though are still feasible. Indeed, the relative discount between the acquirer and acquiree is what actually matters. WAR could trade at a 12% discount and the CD Funds at 20-30% discounts and this can easily represent a worthwhile merge for all shareholders involved if the exchange ratio is a compromise.
I will update this section if any real news emerges about this possibility.
3. Is WAR simply getting some lower correlated exposure at big discounts that will gradually liquidate at NTA?
I believe this is the most likely explanation for the modest positions built so far in CD3, CD2 and CD1. At extremes, the discounts have been over 35%. It's not well understood by those selling a CD Fund at a circa 35% discount that their actual loss on the next distribution paid at NTA is much higher. A 35% discount equates to a 53.8% gain if you get paid out at NTA. Obviously the distributions take time, but this is a huge sacrifice of value, especially if the CD Fund is in liquidation phase and at the time has a sizeable look-through cash position.
For example, for WAR's biggest CD Fund holding (CD3), from 1 July 2021 to 31 May 2023, it has delivered an annualised NTA return of 21.17%. If you'd sold CD3 at a massive 27% discount on June 30 2021 at $1.56 (NTA $2.14) and put the money in VDHG instead you'd have made an annualised return of only 1.86%.
In distributions alone, CD3 has delivered $1.09 in less than 2 years (while the NTA only dropped from $2.14 to $2), noting that the hypothetical seller only locked in $1.56. Interestingly, CD3 was still trading at a 27% discount on 1 June 2023. Over this period, CD3 has easily been the best performing LIC/LIT out of the ~90 on the ASX, yet the discount has virtually always been over 25%.
Of course, one can't invest with hindsight, but it clearly shows that being primarily influenced by market prices or other investor's sentiments leads to underperformance in asset classes like private equity. Indeed, even basing decisions on cash proportions, liquidation stage or comparative unrealised mark-ups would have led investors to preferring CD1 or CD2 over CD3. Deeper insight into specific private equity fund managers and portfolios is a better approach. Hence this blog, and the overall guidance toward patience and analysis.
Absent any major news, I expect WAR's base strategy is simply buying the CD Funds only at acceptably large discounts in order to make the large gains upon distributions at NTA.
4. Will Wilson Asset Management add to pressure on the Responsible Entity to expedite distributions and divestment?
The CD Funds are often holding significant proportions of cash (10-30%) as the U.S. sub-funds liquidate holdings but distributions are delayed. For CD2 and CD3 in particular, significant cash holdings have been set aside to cover possible calls for further capital, even though the extent of any calls is likely to be much less than the maximums.
There is certainly scope for higher profile major holders of CD Funds to increase pressure on the Responsible Entity to be transparent about look-through cash holdings and speed up distributions.
CD1 and CD2 are already not paying their GPs any fees and are well into the liquidation phase, so expediting realisations is unrealistic unless investors want to take a haircut on secondary sales. The extent to which Australian investors can influence the CD3 GP to expedite realisations is unclear.
5. Will Wilson Asset Management seek to internalise the Responsible Entity function?
Samuel Terry Asset Management is a large holder of another E&P fund: URF. It is also opposed to KAM taking over and has instead proposed to internalise the RE function.
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A responsible entity, or RE, protects the rights of unitholders in a trust. An external firm is typically appointed, but some fund managers create their own REs to perform the function.
Samuel Terry is pushing for the creation of an internal responsible entity “who is only accountable to URF unitholders and is overseen by a group of URF unitholders”.
“URF unitholders would become owners of the RE, able to vote for directors of the RE and attend annual meetings of the RE company,” the letter said.
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Samuel Terry to reject URF appointment of K2
In its media release, Wilson Asset Management stated it is:
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..."willing to engage with E&PIL and other unitholders to explore alternative proposals, including but not limited to the appointment of an alternative responsible entity or the internalisation of the RE function."
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6. Extracts from AFR: Geoff Wilson enters Cordish Dixon PE funds fracas, motives unclear
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Geoff Wilson is setting up an eleventh-hour quarrel at E&P’s Cordish Dixon private equity funds.
His listed investment company, WAM Strategic Value, wrote to unitholders in CD Private Equity Fund I, II and III on Friday morning. It urged them to vote against the proposal for K2 Asset Management to take over the responsible entity functions from E&P Investments Limited, which is exiting RE services. (RE is a governance structure that looks after investors’ interests in a fund in return of a small fee).
Wilson’s letter said WAR would be voting its holdings against the responsible entity swap at CD I, II and III because it thought the K2 proposal was “not in the best interests of CD Fund unitholders” and urged others to follow its lead. The unitholder vote is scheduled for June 19 and would need support of 50 per cent of the register for K2 to come in.
However, WAR only has 1 per cent to 2 per cent holdings in the three CD funds – which won’t be anywhere near enough to block the vote.
The letter did not flesh out the reasoning, propose alternatives, or clarify if WAM wanted to make a tilt at the three funds itself.
“It is not the perfect scenario, but the status quo is better. They [E&P] have been winding down the fund and paying the money back,” Mr Wilson said. “I don’t believe the change is in the best interest of shareholders.” K2 Asset Management, which has similar proposals at the E&P’s US Residential Property Fund, CD Fund IV and Venture Opportunities Fund, was selected after a tender process and has promised to lower fees and not stand in the way of the wind down.
It already faces opposition at URF, where Fred Woollard’s Samuel Terry Asset Management has vouched to vote his 12.7 per cent against the RE change – and is campaigning for an internal RE.
Sources said URF was an easy battle for K2 to lose, given its concentrated register. However, CD funds’ unitholder base was more fragmented and could prove to be easier to tame despite Wilson’s opposition, especially if E&P cheers its wealth clients in the register in K2’s direction.
Should K2 be successful at taking over the RE for six funds, it would add $1.68 billion of fee-earning assets to its RE unit. (RE fees are much lower. For example, K2 wants to charge 0.05 per cent of gross assets plus administration fees of 0.225 per cent of the gross asset value – a few basis points lower than the current structure).
On the flip side, should Wilson’s push be successful in locking out K2, it is unclear what he would want to do next.
Wilson’s next move unclear
Wilson declined to comment on what would be WAR’s next move at the three CD funds, should it be successful in blocking the vote to appoint K2.
His firm wouldn’t have the responsible entity structure to have put its own hat in the ring, sources said. But it’s only natural to expect a fight for management control from the camp, especially for higher-margin management fees.
It has plenty of experience in taking over LICs that are performing or trading poorly, often using its own vehicles’ stronger scrip to mop up a smaller rival. It has done at least 11 such deals in the past five years, including Bennelong’s Absolute Performance Equity Fund.
The playbook extends to private markets funds. In July 2020, it won the management rights for the ASX-listed $200 million odd Blue Sky Alternatives Access Fund after an 18-month-long slog.
The Cordish Dixon funds all cut cheques to underlying PE managers, mostly in the Unites States. Fund IV, for example, has money out with Wavecrest Growth Partners, Incline Equity Partners, Tower Arch Capital and Quad Partners, among others.
Their investors have long suffered from traded share prices that are lower than the underlying value. Several solutions have been tried over the years, including a merger and delisting put forward by E&P and roll-up attempts from Pengana Private Equity Trust.
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AFR: Geoff Wilson enters Cordish Dixon PE funds fracas, motives unclear
