• The Next Step for the Ophir High Conviction Fund

    17-Oct-2018 by Ophir

Good stock picking often only forms one part of the outcome of strong investment returns. Ensuring the best possible investment structure is in place to manage capital to a particular strategy can be equally impactful as stock selection on overall long term returns.

We’re delighted this month to announce a proposal to convert the Ophir High Conviction Fund (“Fund”) into a closed-ended vehicle and listing it on the Australian Stock Exchange (ASX) as a Listed Investment Trust.

In both our capacities as investment manager of the Fund and as significant unitholders ourselves, we feel the conversion to a closed-ended vehicle will provide the most optimal investment structure to pursue strong investment returns over the medium to long term.

Investors will shortly be receiving some formal documentation outlining the proposal from the Fund’s responsible entity, The Trust Company (RE Services) Limited, including a Notice of Meeting of Unitholders and Explanatory Memorandum.

Below we have provided our own brief explanation as to what the proposal entails, why we feel it is in the best interests for unitholders and what this will mean for investors over the longer term.

We’re very excited about the potential benefits that the proposed investment structure will provide all investors over the full length of a market cycle. We will also ensure, as always, that we are readily available to speak with investors over the coming weeks to discuss it in more detail.

Should Unitholders agree to the proposal to convert the Fund to a listed investment trust, we anticipate a listing of the Fund (under the ASX code “OPH”) in mid-December this year. This will be subject to us obtaining a draft ruling from the Australian Tax Office confirming the availability of capital gains tax rollover relief for eligible unitholders and ASX approval of the listing.

Why did we cap the capacity of the Funds?

In March of this year, we sent a communication to investors outlining our intention to cease taking any additional investments into the Ophir High Conviction Fund (other than distribution reinvestment). In our view, restricting the capacity, or size, of the amount of capital that is managed in the Fund provides us with the best possible environment to generate strong returns for investors over the longer term.

It’s our opinion that the ability of a fund manager to consistently deliver strong returns through the cycle ultimately diminishes if the size of the capital they manage becomes excessive. This is especially true across investment strategies that are focused across the smaller and mid-cap company space.

While the manager(s) themselves may prove to be fantastic stock pickers, managing a large amount of capital can ultimately preclude them from taking advantage of opportunities they identify, given the liquidity constraints that large funds often face.

This is obviously a sub-optimal outcome for investors and one that we have endeavoured to avoid by capping the capacity of both the Ophir Fund’s. This essentially ensures that the underlying investment structure remains supportive of the investment strategy and provides the best possible environment for us to generate outperformance.

We closed our original fund, the Ophir Opportunities Fund to all additional investment in 2015 and have subsequently ceased taking new investment in the Ophir High Conviction Fund earlier this year.

While still relatively early in their investment histories, we are pleased that the combination of a supportive investment structure and sound stock selection has delivered returns in both funds of over 24% per annum (after all fees) since their respective inceptions.

The Importance of Independence and Alignment with Investors

We’re proud to be a completely independently owned business, with no outside investors or third party distribution arrangements. We’re fortunate to be in the position to have complete autonomy over decisions such as the investment structure of the funds, given the business remains 100% owned by the founders. This removes the conflicts that are inherent within other funds management businesses that instead may have competing ownership interests.

Deciding to limit the amount of capital managed in order to protect investor performance, for example, may run counter-intuitive to a third-party equity owner (or distribution partner) whose primary motivation may instead be focused on raising large amounts of funds under management.

Ultimately, we want our investors to have complete comfort that the decisions being made about how their capital is being invested (and in what structure) are done with their best interests in mind.

Of course, the best way to ensure this is by being significant investors within the Funds in our own right. The entirety of our own liquid personal investments are held across the Ophir Fund’s, alongside the investment capital of our family, friends and all the Ophir staff. This makes us acutely sensitive to ensuring we not only think and act like unitholders, but are always continually striving to protect our capital while earning the best possible return on our investment.

Converting the High Conviction Fund to a Listed Investment Trust

There are two key reasons why we feel the conversion to a close-ended, listed investment trust will provide Unitholders with an enhanced investment structure over the existing open-ended unit trust:

Firstly, the ASX-listing will provide a mechanism whereby existing unitholders, staff and new investors will again be able to purchase units in the Fund.Most importantly, this can be achieved without impacting the current capacity, or size of capital, being managed within the Fund.

By listing the Fund on the ASX as a closed-ended vehicle, investors will be able to purchase units in the Fund via the exchange, assuming existing unitholders are willing to sell them. The amount of units on issue therefore remains fixed, meaning the amount of capital being managed within the Fund also doesn’t change.

While we have certainly been humbled with the continued demand from both existing and new investors to access the Fund, ensuring the capital managed within the strategy stays at a size that is optimal for long term returns is always our priority.

Again, assuming existing unitholders are willing to sell their existing units, the listing will enable individual investors and private wealth groups to again be able access the Fund.

Perhaps more importantly, the conversion from an open-ended fund (where capital flows in and out of the fund as unitholders apply for and redeem their units) into a close-ended fund provides investment managers with one of the most significant competitive advantages available to investors throughout a market cycle: a stable capital base.

In an open-ended structure, such as the existing unlisted unit trust structure, the pool of capital available to be invested isn’t fixed and instead funds moves in and out as investor applications and redemptions are processed.

This means that we, as investment managers of the Fund, ultimately need to ensure that we have enough cash available within the Fund to meet investors’ liquidity requirements. Somewhat crucially, the amount and timing of these capital calls cannot be forecasted.

During times of more volatile markets, for example, investment managers may move to hold slightly more cash than they otherwise would wish to, in anticipation of a heightened level of investors potentially looking to withdraw capital from the Fund.

In the case of more severe market movements or redemption activity, managers can be forced to sell underlying portfolio holdings to provide the cash required to meet investor redemptions, often at sub-optimal prices. This selling will likely occur when the manager would instead prefer to be deploying capital into the market and taking advantage of the attractive opportunities available.

This obviously isn’t an ideal outcome for investment performance. Raising high levels of cash and selling portfolio positions at a time when asset prices are depressed and the risk/reward equation is materially skewed in our favour runs in complete contrast to the investment objective of the Fund.

Given we have all our own liquid assets in the Fund, we want to ensure our capital is in a structure that can benefit from those distressed situations (and ultimately have the ability to purchase stocks from those that are being forced to sell to meet investor capital calls).

When markets are on sale, it is only those with capital available to deploy that will be able to extract the full benefits for their investors. By converting to a closed-ended investment vehicle, the amount of units within the Fund will be fixed and the amount of capital available to invest will not change significantly.

As the Fund will no longer be required to provide ongoing liquidity to meet redemption requests from Unitholders, we will be able to fully deploy the capital available as opportunities present themselves.

Why list the Fund on the ASX?

While closed-ended pools of capital provide a much better structure to deliver strong returns throughout a market cycle, our underlying investors ultimately still need an ability to access liquidity and convert their unit holdings to cash as they require.

In our view, listing the Fund on the ASX provides the best possible combination of delivering a closed-ended investment structure with a fixed amount of units on issue, while also providing a platform by which investors can easily buy and sell their units.

Are you raising additional funds as part of the proposal?

No, there is no capital raising. We’re not increasing the size of the Fund nor are we issuing any additional units to investors. We have always held the strong belief that fund capacity is the asset of unitholders and we will continue to keep our commitment to investors to limit the size of the capital being managed in the Fund.

While the Fund is being listed, the capital has already been raised so there is no Initial Public Offering (IPO) to new investors. The proposal is designed to deliver maximum benefit to existing unitholders that have supported us to date, rather than provide a liquidity event for new investors to enter the Fund prior to it listing.

While we are delighted that there has been such strong interest in accessing the fund, new investors will have to purchase units from existing unitholders on the ASX at the prevailing market price.

What does this mean for existing investors in the Fund?

As mentioned above, we believe there are a number of significant advantages that the conversion and listing of the Fund will provide to investors above and beyond the current structure.

The Fund will be far better protected from the impact of capital outflows and, most importantly, will be in a far better position to be able to capitalise on opportunities through periods of heightened market volatility.

We have been fortunate ourselves to have seen the benefits of access to semi-permanent capital thorough our experience of managing capital at our previous employer through the Global Financial Crisis in 2008. As a fund backed solely by institutional investors with exceptionally long time horizons and a high tolerance of volatility, we were not impacted by the redemption cycle that created significant performance drag for most investment managers at the time.

As a consequence, we were able to deploy capital aggressively toward the bottom of the cycle at a time when a wide variety of companies were trading at incredibly cheap valuations. This access to capital provided us with a material significant advantage over the majority of our peers, with the relevant fund’s returns meaningfully benefitting as result – for the calendar year 2009, for example, the fund delivered a gross return of +131.3%.

While we are obviously passionate about the benefits that stable capital base can provide, there are a number of changes that unitholders will need to be aware of under the new structure.

The most obvious change is the price of each unit in the fund will now be determined by the price and liquidity that is available on the ASX. Where previously investors could simply complete a redemption form and receive the value of their units at the prescribed net asset value per unit at end of day, the sale price received will now ultimately be determined by the market demand of those units on any given day.

This means when demand for the units is high, there is the potential that the units could trade at a premium to their underlying net asset value (NAV). Equally, during times of low demand, there is the possibility that the units could trade at a discount.

Ultimately, this is something we have carefully considered. There are a number of attributes that any listed investment vehicle needs to provide in order to ensure a transparent and orderly market. Good performance is one obvious factor, so too is the ability of the manager to provide constant communication and updated information on the Fund. Pleasingly, we feel we’re in a good positon on both.

Size of the offer is another key variable, with a number of listed investment vehicles tending to trade away from their underlying NAV due to a sub-optimal size. Excluding institutional mandates, the Ophir High Conviction Fund is ~$550m in size, meaning (if listed), the Fund will be the second largest listed small/mid cap fund in the country. The size effectively ensures that investors will have access to better liquidity (as there are a larger number of investors and units on offer) and also that the Fund is relevant to new potential buyers.

If the Fund becomes listed, we’ll also be introducing a number of additional measures designed to ensure that the market price of units is correlates closely with the underlying NAV, namely;

  • Provision of Daily Net Asset Value to the ASX

To ensure the market remains efficient and well informed, the Responsible Entity of the Fund, will provide a daily release to the ASX disclosing the Net Asset Value of the Fund (as we do today, via our website)

  • Inclusion of a Standing On-Market Buy-Back Mechanism

Following listing, we are intending on having a standing on-market buyback facility in place that will operate in the market below the Fund’s NAV.

Will the investment strategy change?

Not at all. The strategy, process, people and manner in which we have invested your capital over the last three years in the High Conviction Fund will not change (and neither will the size of the Fund).

If anything, the proposed changes will ensure that we aren’t required to alter the manner in which we would otherwise seek to generate investment returns due to unpredictable capital flows in and out of the Fund.

We never want to make an investment decision based solely on whether an investor is choosing to enter or exit the fund – our greatest desire is simply to deploy capital into good companies where we feel we can generate a meaningful return on our investment.

Are there any costs to me as an investor in converting the Fund to a listed investment Trust?

No, not to you as an investor and nor to the Fund directly.

There are a number of fairly significant costs involved with putting the conversion together, from initial ASX listing fees to various legal and accounting fees associated with the listing. While we feel the conversion will be of significant benefit to the Fund and underlying unitholders, we (as Ophir Asset Management Pty Ltd) will be bearing all the costs of the conversion.

There is no intention to change the current fee or expense recovery arrangements for the Fund, however operating costs as a listed entity may lead to some slightly higher costs being borne by the Fund over time (additional fees to the ASX etc). These are not, however, overly significant.

Will you be also be listing the Ophir Opportunities Fund?

Not at this stage. We obviously favour the closed-ended structure and feel it creates the best possible environment to generate long term outperformance. Given this, we wouldn’t want to rule out converting the Opportunities Fund as it would be able to take advantage of the benefits outlined above.

The Opportunities Fund, however, is a smaller fund in overall size and we would have some concerns that the lower levels of liquidity (given a much smaller unitholder base) and overall market cap could potentially make it more susceptible to trading away from its NAV.

What are the next steps?

Over the next few days, investors will receive some formal documentation from the Responsible Entity outlining the proposal, complete with a Notice of Meeting and an Explanatory Memorandum. We’ll also be launching a dedicated website that will contain links to all the documentation, some insights from us and Frequently Asked Questions.

This is an important proposal and requires your close attention. We are very passionate about delivering the best returns for investors and feel this is the best structure available for us to pursue consistent outperformance over the long term.

As significant investors in the Fund ourselves, we’d be delighted to talk to you about why we feel this is the best outcome for our own investment and would encourage investors to get in touch to talk through the proposal in more detail.

You can do this via emailing us or Ophir Investment Director Rob Saunders directly at ophir@ophiram.com or calling through on (02) 8188 0397. This is an exciting time for the Ophir High Conviction Fund and we’re looking forward to discussing the proposal in more detail over the coming weeks.

 

This document is issued by Ophir Asset Management (AFSL 420 082) in relation to the Ophir Opportunities Fund & the Ophir High Conviction Fund (the Funds) and is intended for wholesale investors only. The information provided in this document is general information only and does not constitute investment or other advice. The content of this document does not constitute an offer or solicitation to subscribe for units in the Funds. Ophir Asset Management accepts no liability for any inaccurate, incomplete or omitted information of any kind or any losses caused by using this information. Any investment decision in connection with the Funds should only be made based on the information contained in the Information Memorandum and/or Product Disclosure Statements.