I first wrote about Aurora Investment Trust (ticker: ARR) in June last year; I had initiated a position in the expectation that the trust would soon be wound up, given the continuation vote due at the trust’s 2014 AGM (which will be held on 18 July). Such an outcome seemed to me almost inevitable, in view of the trust’s small size and poor performance, and the trust was trading at a substantial discount to its net asset value. I had expected the trust to go quietly; however, the outcome is not now as clear-cut as I had originally thought. While I still own a significant position in Aurora, in view of the increased uncertainty, I have reduced the size substantially.
At the time of its interim results in October last year, the trust’s Chairman said he would “be having a programme of meetings, this autumn, with all Aurora’s major shareholders; its purpose is to discuss proposals for the future of Aurora. Thereafter I will be writing to all shareholders to advise on the options for Aurora.”
I was disappointed that nothing further was heard on this, until the full-year results were recently announced, around seven months later. No proposals have been forthcoming and no letter to shareholders setting out the options. Instead, in the results announcement, the Chairman stated: “I have made contact with all major shareholders, representing an overall majority, earlier this year, from which conversations I have found a substantial level of support among shareholders in favour of Continuation.”
This surprised me. I thought the consultation would result in a clear consensus against continuation and the decision to put a proposal to shareholders to wind up the trust without the need for a continuation vote. However, it seems that the only option available, apart from winding up the trust, is to carry on as before, with the hope that the market will eventually recognise the value in the trust’s portfolio.
Investors expect a trust like this, which is an expression of the manager’s stock picking, to take large, concentrated positions that will result in high volatility and periods of underperformance. As the Chairman says, the trust is “high beta”, in part due to the nature of its investments and also the structural gearing from the use of debt. The flipside of this is the expectation that, over the long term, the trust will comfortably outperform its benchmark.
In the 3-year period up to February 2014, the trust’s NAV per share fell 29%, compared with an increase of 34% in its benchmark, the FTSE All-Share index. The trust has also underperformed over one and five years. Between 2009 and 2014, the its NAV increased by 71% compared with a 90% gain for the benchmark—a 19-percentage point shortfall. The performance in the prior five-year period, between 2004 and 2009, was also poor: the NAV fell by 40% compared with a decline of 14% for the benchmark—a difference of 26 percentage points. Over a ten-year period, the trust’s NAV is in effect unchanged, while the benchmark has increased by more than 60%.
The problem is not so much the magnitude of the trust’s underperformance in recent years, although this has been substantial, but the manner in which it has occurred. The trust’s portfolio has been so narrowly focused, with large positions in speculative stocks, that it is hard to put the poor performance down solely to bad luck. It should be noted that the trust’s first objective is “to achieve a positive total return over the long-term”. However, it is hard to avoid the conclusion that, at least in part, long-term investors in the trust have suffered a permanent diminution in value.
The underperformance in the earlier 5-year period was in large part due to the trust being stuffed with Irish stocks, UK housebuilders and miners in the run up to the financial crisis. In August 2007, five of the trust’s ten largest positions (including the four largest) were: Gartmore Irish Growth investment trust (9.0%), Rio Tinto (8.5%), Persimmon (8.3%), Anglo Irish Bank (7.7%) and Barratt Developments (3.4%); in total, they accounted for around 37% of the trust’s assets.
The major contributor to the trust’s underperformance in recent years has been its investments in AIM-listed overseas companies. In February 2011, the trust’s four largest holdings were GCM Resources (9.5%), West China Cement1 (7.4%), Asian Citrus (7.2%) and Petro Matad (7.0%). Together, these made up 31% of the portfolio. While the trust did reduce its shareholding in some of these stocks, following a strong run in 2010, their subsequent weak performance means that, overall, these have proved to be poor investments. The trust has retained shareholdings in all these companies, although they now account for a much smaller part of the portfolio. Nonetheless, the recent investment in Chinese sportswear company, Naibu, demonstrates a continuing enthusiasm for similar stocks.
Naibu certainly appears exceptionally cheap based on its published financial statements. However, its very cheapness inevitably sets alarm bells ringing. The low valuations at which many AIM-listed Chinese companies are trading, does bring to mind George Akerlof’s market for lemons. Why do companies list on a market that attaches such a low value to them? This may be unfair; there are some reasons why it might make sense, and I’ve not done sufficient research to comment on this company specifically. But, to suggest, as the manager does, that Naibu is clearly a better investment than Unilever, is clearly ridiculous. Stocks like Asian Citrus and Naibu are not blue-chip companies, which have somehow been overlooked by the market. They are speculative, and controversial, investments. Asian Citrus, in particular, is well known to a large number of investors. I do not think it is reasonable to assume that the stocks’ current low valuations represent just a temporary mispricing.
For an investor looking to gain exposure to the growth opportunities offered by Chinese companies, in my view, it makes little sense to look solely at the meagre choice listed on AIM. Hong Kong offers a much wider choice of investments; many of which also offer good value and are less speculative. It is not clear to me what advantages AIM-listed stocks offer. I also find it difficult to understand how a UK-based fund manager is able to gain sufficient conviction in a small-cap Chinese stock to be willing to hold 10%+ position in it. Are such stocks really within their “circle of competence”?
I am sceptical that a turnaround in the trust’s performance is necessarily just around the corner (reading the annual reports, it has been for several years) and the portfolio will flourish when the market comes to its senses. At some point the trust will inevitably put in a strong performance, but I do not think it is worth holding out for this. In my view, the risks are equally on the downside.
Equally important to concerns about performance is that, with a market cap of just £17m, the trust is too small to be viable. This resulted in an ongoing charge ratio last year of 2.2%. The bid–ask spread is also wide, typically several percentage points. Liquidity in the shares is reduced by the concentrated nature of the shareholder base: the seven largest investors hold two-thirds of the shares. This includes the manager, who has a shareholding of nearly 9%. As a result, large shareholders will struggle to sell their positions. If shareholders do vote in favour of continuation, the discount may widen from its current level of around 16%, particularly if some investors decide to sell their shares. The trust’s small size also means it is unable to control the discount with further tender offers.
The trust’s largest shareholder is CG Asset Management (CG), which manages the Capital Gearing investment trust and other similar funds. According to stock exchange disclosures, it has an 18.6% shareholding (although the annual report suggests it is 17.6%). CG has increased its shareholding from around 13% over the last year or so, although the investment in Aurora represents a relatively small part of its total assets. CG is a specialist investor in closed-end funds and, while it is not specifically an activist investor, it will look to take advantage of corporate actions like trust wind-ups. Miton Asset Management (MAM) is the third largest investor with a shareholding of around 10%. It has a couple of funds, run by investment trust specialist Nick Greenwood, including the Miton Worldwide Growth Investment Trust, that invest in closed-end funds. The Miton trust has been a long-term holder of Aurora, which is one of its largest holdings. MAM has increased its overall shareholding in Aurora to around 10%, up from 7% a year ago. MAM is not specifically an activist investor, but it does aim to exploit “inefficiencies in the pricing of closed-end funds”. Henderson Global Investors is the sixth largest investor with around 8%. Henderson built up its shareholding just over a year ago, although I have been unable to find out which Henderson fund, or funds, holds the position. My assumption had been that these three investors, which together own over a third of Aurora’s shares, had increased their holdings in anticipation of the trust being wound up and would therefore vote against its continuation.
Two of the largest shareholders are the private client businesses of Jupiter Asset Management and Brewin Dolphin. Both have been long-term holders. According to Aurora’s annual reports, Jupiter has reduced its aggregate shareholding from 14% to 12% over the last year. Brewin Dolphin has reduced its aggregate shareholding in recent years to just over 3%. These managers are a difficult position, as it is difficult for them to buy or sell shares without impacting the share price. In most circumstances, I expect them to vote in favour of a wind-up and take advantage of the opportunity to exit at a premium to the prevailing share price.
The two remaining major shareholders are the fund manager, James Barstow, who has a shareholding of nearly 9%, and an individual investor, who has an 8% shareholding, which he has held since 2011. It is unlikely that the latter will be happy with a near 40% decline in the share price since then, but I assume both these shareholders will vote for continuation.
My previous assumption had been that all five corporate shareholders would vote against the continuation—in aggregate they control 50% of the shares. I now suspect that one, or possibly more, of these shareholders, perhaps MAM, has decided to give the manager another chance and plans to vote for continuation (another continuation vote would be held in 2017). This would leave the trust’s fate more evenly balanced; the Chairman’s indication that there is “a substantial level of support” for continuation is suitably vague. It will be interesting to see how the vote goes. My feeling is still that the vote will be against continuation. However, it is possible that I have misread the level of support for the manager and the trust survives. If this were to happen, despite the trust’s wide discount, I would look to reduce my remaining position and possibly sell it entirely.
1 West China Cement moved its listing from AIM to Hong Kong in 2010.