Aurora Investment Trust (ticker: ARR) is a UK-listed investment trust. After a run of poor performance, it recently announced plans to consult with shareholders about the trust’s future. It is currently trading at a discount of around 14% to its net asset value.
The fund is highly concentrated: it has around 35 holdings, although it is more concentrated than this would suggest: the 10 largest positions account for close to 60% of the fund. Furthermore, at the time of the last Annual Report, 12 of its holdings were for less than 1% (I’m not sure what the point is of having shareholdings of 0.5% in GlaxoSmithKline and BAE Systems). The fund’s benchmark is the FTSE All-Share Index. However, the fund cannot be accused of being a closet index tracker: its performance has not followed the index closely at all. This is not necessarily a problem. Research suggests that an unconstrained investment style offers the best chance of outperforming the market. However, for a fund such as this, whose main rationale is the fund manager’s stock-picking ability, it needs to deliver superior performance.
The trust has a decent long-term record since it was launched in 1997. However, its recent performance has been particularly poor: according to the Association of Investment Companies, it has been the worst performing trust in the UK Growth sector over the last 5 years. After a strong showing in 2010, its performance has been particularly dire since then: from the end of 2010, its NAV has declined by 42%, compared with an increase of 7% in the benchmark. The fund had a terrible 2011: its NAV fell 34%. The poor performance continued in 2012; and so far, it has not improved in 2013. In each period, it has underperformed the benchmark by a wide margin. The trust’s financial gearing has exacerbated the underlying poor performance. At the last year-end, the shrinkage in assets meant that gearing had increased to 22%. The nature of the funds holdings and the financial gearing means the performance of the underlying portfolio has also been volatile.
A fund such as this is likely to have periods when it underperforms: sometimes for by large amounts and long periods. However, such a run of underperformance is likely to try the patience of even the most loyal supporters. The magnitude of the decline in absolute terms has effectively resulted in a permanent destruction of value. The trust may have been unlucky to a certain degree, but it has also been the author of its own misfortune. It had big positions in what can only be regarded as lower quality, speculative investments; many of its largest holdings have been London-listed foreign companies. At the end of 2010, its largest positions were: GCM Resources (Bangladesh, coal); West China Cement; Asian Citrus (China, oranges); BTG (specialty healthcare); Antofagasta (Chile, copper); and Kazakhmys (Kazakhstan, copper). Together these accounted for nearly 50% of the trust’s assets. The trust took a big bet on growing demand for natural resources. Together, mining and oil & gas stocks accounted for over half of its investments; mining stocks alone accounted for 35% of assets. More specifically, the trust was betting on a continuation of growing demand for raw materials in developing markets. In particular, it was a bet on Chinese growth; the trust had a further 9% invested in a Chinese cement company. Whilst it is the job of a fund manager to make calls based on their “conviction”, to bet the fund on what is effectively an unknown, and unknowable, outcome is extremely risky. It paid off in 2010, but has proved disastrous since then. Despite the poor performance, ARR has stuck with its investments: it is a long-term investor. Share turnover is unusually low. In fact, its holdings barely seem to change from year to year: of the current top 10 holdings, only one (Persimmon) was not held at the end of 2010. The trust remains overweight the mining sector.
The other main reason to question the viability of ARR is its size: its market value has shrunk to only £14m following share buybacks and the fall in its NAV per share. It is therefore very illiquid and consequently has a relatively wide bid-ask spread. The small size also means that the expense ratio is high at around 2% of net assets annually. The trust is too illiquid for most institutional investors or private client managers, whilst the concentrated nature of trust’s portfolio means that it is not suitable for many retail investors. The trust’s share count has decreased by around 30% in the last few years. In 2011 and 2012, it held tender offers for 10% of the share capital (at a discount of 9%). However, given the fall in the fund’s size, it has decided not to hold a tender offer in the current year. A continuation vote is scheduled for next year’s AGM in July. However, in its recently released full year results, the trust announced that it plans to contact “shareholders to discuss proposals for the future of the Company”. In short, it is almost certain that the trust will be wound up in the next 12 months. The only thing that could potentially save it would be a major turnaround in its performance.
The trust is currently trading at a discount of around 14% to NAV. The discount has been quite volatile in recent years, mirroring the underlying performance; widening to 20% on a number of occasions, having been below 10% for much of 2010. It has narrowed somewhat in 2013. There was no reaction in the share price on the day of the results announcement, which is surprising. I bought an initial position in the trust at a discount of around 16% to NAV (although this was prior to it going a ex a dividend of 3.75p), which provides potential outperformance of around 17% relative to the NAV in the event of a wind-up, assuming costs of say 2%. Some of the trust’s holdings are quite illiquid. I think the trust is a bit misleading in suggesting that it is weighted towards larger cap stocks: some of its largest shareholdings are in small or microcap stock. But given the small size of the fund, overall, disposing of its positions should not be too difficult.
I have bought a relatively small initial position in the trust, which represents around 3.5% of my portfolio. I will look to add to my shareholding, depending on the discount level and news flow. The trust is illiquid, but it is reasonably easy for a small investor to buy a meaningful shareholding. I think it is unlikely that the trust will get to hold a continuation vote in 12 months time. The simple fact is that at its current size it is not viable as an investment proposition. I expect a further announcement on the trust’s future in the next few months. The only factor, which might feasibly save the trust, is a rapid turnaround in its performance, although I think this is unlikely. In either case, barring a very weak underlying performance, the investment should provide a good return over the next year or so.