Monash Absolute Investment (MA1.ASX) – NAV Discount Elimination – 10% Upside

Current Price: A$1.07

Current NAV: A$1.18 (post-tax)

Upside: 10%

Expiration Date: Q1 2021

Investor presentation

This idea was shared by Writser.

 

This is a very simple idea, nevertheless, it is one that I like and own. Liquidity is somewhat limited.

 

Executive summary

MA1 is a microcap listed managed fund (~A$48m market cap), trading at a ~10% discount to net asset value (NAV). The company's shares are listed on the Australian Stock Exchange (ASX). Management has been trying to close the discount for a while. Their final solution is to try and convert the fund to an exchange-traded managed fund (ETMF). What does this mean? MA1 basically becomes an actively managed ETF. A market maker can create and redeem at NAV and will give quotes around ‘real-time NAV’ during trading hours. In other words, ignoring some slippage, investors will be able to enter and exit the fund at NAV. So the discount will completely disappear. The fund itself is reasonably diversified and has a decent track record. The conversion is expected to close in early 2021. So, if everything goes according to plan your expected return is basically ~10% plus whatever the fund is doing, in half a year or something. Sounds pretty good to me!

 

Conversion to ETMF

The fund initially came up with the idea to convert to an ETMF in August 2019. You can read the initial proposal here. To facilitate the restructuring, the fund is to be split into two parts. All unlisted investments, some tax assets, and some cash will stay in the current vehicle, which will be delisted. All listed investments and the remaining cash will be spun off in the actual ETMF. The unlisted assets are estimated to be only ~3% to ~4% of NAV, so the listed ETMF will contain the vast majority of all assets. The delisted vehicle will be placed into run-off and distribute proceeds to shareholders. For some more color, I recommend you listen to the conference call from last August. I uploaded a computer-generated transcript (with a few errors, unfortunately) here.

ma1

One of the major risks at the time the MA1 conversion to ETMF proposal was made was that the Australian regulator (ASIC) paused admissions of new managed funds. The regulator did this because ETMF’s are more opaque and often more expensive than regular ETF’s. Anyway, the ASIC review was completed late in 2019, the regulator came up with some guidelines and best practices and subsequently, the pause on new admissions was lifted. Noteworthy is that ASIC stated that it: “intends to work with market operators and other stakeholders to ensure new funds being admitted for quotation use compliant models.”

Unfortunately, the regulatory review took a bit longer than expected. After that Corona struck, so the whole conversion process is already beyond schedule. Both these factors might contribute to the market being somewhat skeptical, hence the current discount. However, as per the latest presentation (September 3, 2020):

  • The new ETMF fund, MAAT, has already been established;
  • An in-principle application to the ASX has been made for MAAT;
  • Agreements with a market maker, administrator, and broker have been negotiated.

The conversion will require shareholder approval. A meeting is scheduled later this year and they hope to complete the conversion in early 2021. This looks like a formality to me as the conversion is in the interest of all current investors.

As of the 7th of Sept, pre-tax NAV was A$1.2108/share. Post-tax NAV is the relevant metric for the ETMF. Pre-tax NAV is only relevant for retail Australian investors due to their ‘franking credits’ tax system. Post-tax NAV is disclosed only on a monthly basis but has always been about 3 or 4 cents below the pre-tax NAV this year. The latest available data point was given for the 31st of July: pre-tax NAV: $1.1222/share and post-tax NAV: A$1.0945/share. So, while it is hard to determine the exact NAV of the fund, I’m pretty sure it is around A$1.18/share, and updates are posted frequently.

You can currently buy at A$1.07. Once the conversion has been completed investors will own the delisted original vehicle, worth about A$0.04/share (see NAV part in MA1 section below), and the exchange-traded vehicle, which should be sellable around NAV, or A$1.14/share assuming the value of the portfolio remains stable. While it is hard to calculate an exact IRR, I think the discount closing will add a very respectable alpha of about ~10% in half a year in an optimistic scenario. And even if you make conservative assumptions about slippage, costs, fees, and discount the unlisted vehicle, I think the discount closing will yield more than 5%, equalling a double-digit source of alpha when annualized.

In short, you buy and wait a few months until the discount elimination, while there is also a possibility of additional upside from the fund performance during this period. The expected return is very decent. I think the main reason that this discount exists is simply that this is an illiquid microcap fund. The opportunity is too small and illiquid for professional arbitrageurs and retail investors are not really interested in trying to buy a $10k position to capture an expected few hundred dollars either.

 

MA1

Regarding the performance (and holdings) of the fund, I recommend you check out the website of the fund (here). Some basic facts: the fund has a 1.5% + 20% fee structure. Unfortunately, that is pretty expensive. You can sift through past annual reports to see what the portfolio looked like the past few years and they discuss their holdings in their monthly updates. Nothing crazy: no extremely large positions, no leverage. On the ASX website, you can find a weekly NAV update and the occasional presentation (here).

 

Main risks

  • The conversion doesn’t go through. That would be pretty bad, as historically MA1 has traded at a much wider discount. I see the shareholder vote as a non-issue and think the largest risk is regulatory. On that front, the conclusion of the ASIC review in 2019 seemed reassuring. New funds are admitted again and the ASIC talks about ‘cooperation’ with stakeholders.
  • The conversion takes longer than expected. A more probable risk. However, given how far things have progressed according to the latest update, I think it is unlikely that the conversion will take another year. A delay of a few months could be possible, but would not be a disaster either.
  • The market maker will quote the EMTF at such a wide spread that you will lose most of your profits. I think this is extremely unlikely, as usually, the market maker signs a contract with a minimum spread, and even if that is an egregious 5%, you still stand to make a decent profit. But my best guess is that it will trade similarly as it does now, with a 1 or 2 cent spread.
  • The Australian stock market collapses. If you want you can short an Australian ETF or try to hedge the underlying portfolio in another way. I personally am fine with this risk.
  • The illiquid investments are worth nothing and/or liquidation of the original vehicle will take a long time. However, these assets make only 4% of the portfolio so it doesn’t affect the thesis in a material way. Also, the company expects ‘liquidity events’ in a 6-24 months time span.
  • At the moment there are 200k options outstanding with a strike of A$1.15. These do not change the thesis in a meaningful way. Interesting is that these are ‘follow-up’ options, issued to investors who exercised the first tranche of options. The original options were just out of the money upon expiration but were nevertheless still exercised by Simon Shields, the fund manager. Insiders now own 1.4m shares or ~3% of shares outstanding. Not very relevant, but a minor positive.

12 COMMENTS

  1. dt

    Thanks for the interesting write-up. Couple questions:
    – Are you aware of any other examples of actively managed ETFs with 1.5%/20% fee structure and are these really trading at NAV or with a minimal discount to NAV? I am concerned that market maker spread (and in turn discount to NAV) might end up higher due to this high fee structure and lower liquidity?
    – What would you recommend for the hedge? ISO.AX seems like quite a good proxy from a historical correlation perspective. Being unhedged with only 10% potential upside within 6+ months seems like a tough call.

  2. Writser

    Good questions.

    1. No, I am not aware of them. There should be quite a few ETMF’s in Australia though, given that the ASIC decided to actually start investigating them. And yeah, the spread might be a bit wider. But I doubt it’d be > 5%, that would be pretty terrible for a market maker. Assuming it’s one of the big firms they can just add the product to their computer, add the exposure to their big internal pile and if they get long too much they can just redeem their position at NAV the same day. Also, if the market maker spread is wide I assume there would still be retail people offering liquidity within the spread, or you could place an order yourself. The current spread is 1%- 3% and I doubt it will get much wider. But it’s a risk, true.

    2. I haven’t really thought about that. I’m fine with the exposure and am not going to try to use extra margin / slippage / to try to capture the spread with an imperfect hedge. Also, I’d say being unhedged with 5-10% extra alpha in half a year is actually a great proposition, unless you are a market timer.

  3. Writser

    An unfortunate update: Monash just reported their NAV for August: https://hotcopper.com.au/threads/ann-nta-august-2020.5619200/ . While pre-tax NAV is in line with previous guidance, the tax liability has increased substantially. Post-tax NAV was only A$1.1756. That would imply a current NAV that is about $1.15 / $1.16, making the whole situation significantly less attractive.

    And, even worse, maybe I didn’t think the tax consequences through good enough .. With Monash currently being a company, rather than a fund, it is paying a capital gains tax of 30%. So it kind of makes sense that when pre-tax NAV is up 10 cents, post-tax NAV is up ‘just’ 7 cents. Which means that the fund structure is inefficient from a tax perspective.

    I have to research a bit more what will exactly happen with the tax liabilities the moment the fund converts into an ETMF. Will they all have to be paid in cash? Is there a loophole that allows them to be deferred or cancelled while the stub is in run-off mode? Or can certain Australian shareholders take advantage of the pre-tax NAV and will it be possible for me to sell to them just before the conversion to ‘arbitrage’ the potential tax losses? Until I have that figured out I don’t think it is that great of an opportunity at current prices. Current discount is ~7.5%, further gains will be taxed at 30%.

    Any insights would be appreciated.

  4. Gosupress

    I thought this was a pretty sweet idea. Tax liabilities are such a headache. But I’d surprised if this created a significant taxable event. I think in the U.S. it is possible to convert a mutual fund to ETF in a tax-efficient manner.

    Monarch says the post-tax number includes deferred taxes. But these stay in the original vehicle.

    In the proposed conversion document they state that approx 96% of the NTA will go to the ETF. This suggests to me that they are able to do the conversion in a tax-efficient manner.

    Are you sure they are a regular company and taxed at that 30% capital gains tax rate. Lots of countries have vexingly complex rules on how to structure a vehicle so it can be used as a fund type vehicle. It is quite rare to come across “funds” that are structured in a tax-inefficient manner.

    1. Writser

      Unfortunately I am pretty sure about the 30% capital gains tax, check for example page 34 of the annual ( https://www.asx.com.au/asxpdf/20200819/pdf/44lnvydb1pcfz5.pdf ).

      I’m not sure about what will happen with the tax assets / liabilities when the fund converts into a transparent (for tax purposes) entity. As you and others pointed out to me, in other countries it sometimes is possible to defer or sidestep these taxes when converting a fund structure. I have asked the fund manager a couple of questions about this and am waiting for a reply. So far he has been pretty accessible and straightforward.

      For now I am assuming the worst-case: taxes have to be paid and further gains will be taxed at 30%. That makes the current price marginally attractive.

      1. Writser

        CEO not being super helpful, but this is what I received ..

        “Pre-Tax NAV is relevant for those that pay less than the Australian company tax rate or have tax losses elsewhere. In Australia you get a refund from the tax office to the extent that the franking credits are an overpayment of tax on your behalf as a taxpayer. For Superannuation funds the tax rate is 15%, so they get a refund. Some people pay no tax so they get it all back. Most investors in MA1 are individuals or Australian superannuation funds. So yes, there will be others it’s worth more to.”

        No answers on what will happen with the tax liabilities during conversion. Still not completely clear to me.

  5. Ilja

    As of the 25th of September, pre-tax NTA stood at A$1.208/share. So post-tax was somewhere around A$1.15/share, presenting 5% upside to current prices.

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