Edge Performance VCT Sorted

The Edge Performance VCT (EDGH and EDGI) I have long considered to be a basket case of the first order. VCTs are typically owned only by private shareholders but I am always astonished by how those shareholders put up with dire performance and excessive management costs over many years. But in the case of Edge they have finally taken action – namely removed all but one of the directors at the AGM and voted down other resolutions. It was not even apparently necessary to call a poll as the resolutions were defeated on a show of hands vote according to the RNS announcement of the result, but the proxy votes were clearly of the same mind.

The sole remaining director is now apparently considering what to do next. See this report by ShareSoc on the meeting: https://www.sharesoc.org/blog/vcts/edge-another-vct-problem-case/

I would suggest the answer is simple: ask for volunteers with relevant experience from the shareholders to serve as directors before deciding on any future plans.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Ventus VCT AGMs – A Disappointing Result, National Grid and Sports Direct

I have mentioned previously the attempt by a shareholder in the Ventus VCTs (VEN and VEN2) to start a revolution, i.e. replace all the directors and appoint new ones. See https://tinyurl.com/y6e5fafo . Nick Curtis was the leader of the revolt but at the AGMs on the 8th August the required resolutions were narrowly defeated with one exception. This was after the boards of these companies paid a proxy advisory service £38,000 to canvas shareholders, which of course shareholders will be paying for as it is a charge on the companies.

There is a report on the meetings by Tim Grattan in the ShareSoc Member’s Area which gives more details. One surprising bit of information that came out was that the performance incentive fee payable to the manager would be paid in perpetuity even if the management agreement is terminated. This is an outrageous arrangement as it would effectively frustrate any change of manager, i.e. it’s a “poison pill” that protects the status quo.

In addition the performance fee calculation is exceedingly complex, and allegedly double counts the dividends because it is based on the sum of total return and dividends. It seems to be yet another incomprehensible performance fee arrangement which I have often see in VCTs.

Comment: I think the existing directors deserve to be removed solely for agreeing to such arrangements. I have repeatedly advocated that performance fees in investment trusts (including Venture Capital Trusts) are of no benefit to shareholders and typically just result in excessive fees being paid to fund managers. There is no justification for them. Fund managers say that they are essential to retain and motivate staff, but I do not know of any VCT where the fund manager has voluntarily given up the role because of inadequate fees being paid even though some of them have had quite dire performance.

The boards of these VCTs are reflecting on the outcome. Let us hope that they decide it is time to step down and appoint some new directors who need to be truly independent of the manager. The candidates for the board put forward by Nick Curtis are a good starting point.

If the board does not respond appropriately, then I think shareholders should pursue the matter further with another requisition for an EGM to change the directors. It can take time to educate all the shareholders in such circumstances so perseverance is essential in such campaigns.

The Financial Times had more lengthy coverage on National Grid (NG.) and its power outage last week, which I covered in a previous blog post. It seems the company is blaming the power failures on the regional distribution operators for cutting the power to the wrong people, e.g. train line operators rather than households. But they suggest otherwise. Meanwhile an article on This is Money suggests that the increased sales of electric vehicles will cause the grid to be overloaded by 2040, even though sales of such vehicles are well behind those in some other countries. They were only 2.5% of sales in the UK in 2018, versus 49% in Norway. Surely what the UK needs is more back-up capacity based on batteries, gas turbines or like the Dinorwig pumped storage power station in North Wales. That can bring large amounts of capacity on-line in seconds and is well worth a visit if you are on holiday in the area.

Other interesting news is the recent events at Sports Direct (SPD). After problems with the last audit and getting the results out, Grant Thornton have announced that they do not wish to continue as auditors. All of the big four audit firms have refused to tender for the audit and other small firms have also declined it seems. Corporate governance concerns at the company seem to be one issue.

A UK listed company does require an audit so what does the company do if there are no volunteers for the role? The FRC is being consulted apparently on how to resolve this problem. Needless to say, these issues are having a negative effect on the company’s share price.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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ProVen VCT AGM Report

I commented on the results of ProVen VCT before their AGM on my blog. I said: “Total return to shareholders was 10.3% last year, but the fund manager did even better. Of the overall profits of the company of £18.6 million, they received £7.7 million in management fees (i.e. they received 41% of the profits this year). That includes £5.6 million in performance fees. Studying the management fee (base 2.0%) and the performance fee, I find the latter particularly incomprehensible. I will therefore be attending the AGM on the 3rd July to ask some pointed questions and I would encourage other shareholders to do the same. I am likely to vote against all the directors at this company”.

I did attend the AGM on the 3rd July in London, but so far as I could tell there were only two other ordinary shareholders present. No presentations and it was a hot day in London that might have deterred some from attending. In essence picking a summer day for an AGM and not providing any special reason for them to attend is a good way to put off shareholders from doing so.

But I did meet with the Chairman, Neal Ransome, and two representatives of the fund manager before the AGM commenced to go through the performance fee figures. The performance incentive fees are based on a very complex calculation which is essentially based on the growth in net assets of the fund plus dividends paid out, i.e. on Total Return. The manager gets 20% of any excess over a hurdle rate. The hurdle rate is the higher of a 25% uplift on initial net asset value or the initial net asset value compounded by base rate plus 1% per annum. That is on top of a “base” fee of 2.0% of net assets per annum payable to fund manager Beringea.

If one is going to have a performance incentive fee, that is not an unreasonable system. But I had already told Neal that I considered all performance incentive fees should be scrapped and a simple base fee used instead (as for example Amati AIM VCT use and other VCTs used before performance fees became common). Performance fees do not improve performance because managers have a good incentive to perform to the best of their ability anyway – if they do and the fund grows they get higher fees.

One complication in the calculation of the performance fees is that they are actually calculated separately on each of seven tranches of the funds that have been raised on previous years. There is also an additional PIF performance fee related to two specific investments. In essence, the calculation is so complex that no investor in the shares of this company could ever work it out or check that it is reasonable. I hope the auditors can do so.

The reason for the exceptionally high performance fee last year was explained as being due to the very high dividends paid out, which primarily were driven by the exceptional realisations during the year. Plus some “catch-up” from previous years having passed the hurdles. VCTs cannot generally hold on to cash because the VCT rules require them to reinvest the cash quickly which can be very difficult to do so and shareholders like the tax-free dividends anyway.

Investors have done reasonably well from this VCT (comparing them with generalist VCTs reported by the AIC), but over the last 10 years the average percentage of the year end net asset value represented by overall management and administration fees is 5.5% so the manager has done very well indeed.

The AGM was a fairly trivial event with only I and one other shareholder asking any questions. I voted against the reappointment of Malcolm Moss as I don’t like fund manager representatives on boards of trusts and told the board so – he was not present in person. All the directors should be independent in trusts which he is clearly not.

I asked whether there was any difficulty with the new VCT rules which requires a focus on earlier stage companies. Response was no but there was lots of money in the market so there was lots of competition for new deals and so pricing tends to be high.

I also asked about two of the holdings that suffered large write downs. Due to reduced market multiples on retail and ecommerce companies and underperformance respectively was given as the explanation.

Another shareholders asked about a possible merger of the two ProVen VCTs but it was said there are advantages in keeping them separate – for example it enables shareholders to sell from one trust and immediately reinvest in the other when if they did that in the same trust they would lose tax reliefs.

All resolutions were passed on a show of hands vote, with no significant proxy votes against any of the resolutions except for the remuneration report (4.9% against).

Are shareholders likely to revolt over the high levels of fund management fees at this company? I doubt it, but I think the directors should tackle this issue because the fees are unreasonable. The relatively good performance of the fund manager, which may be partly from chance, tends to end up in the hands of the manager rather than the shareholders. But if the fund underperforms it’s only the shareholders that will suffer.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Bonmarché Update, FCA Grilling over Woodford and Amati AIM VCT AGM

Yesterday Bonmarché (BON) conceded defeat in its opposition to a takeover bid at 11.4p. On the 17th May it had rejected the bid because it “materially undervalues Bonmarché and its prospects”. The share price of this women’s clothing retailer was over 100p a year ago but the latest trading review suggests sales are dire because of underlying weakness in the clothing market and “a lack of seasonal weather”. Auditors might have qualified the accounts due to be published soon due to doubts about it being a going concern if sales did not pick up before then. Bonmarché looks to be another victim of changing shopping habits and changing dress styles.

Is the market for traditional men’s clothes any better? Not from my recent experience of buying two formal shirts from catalogue/on-line retailer Brook Taverner. Cost was zero although I did have to pay postage. Why was the cost zero? Because they had a special offer of 60% off for returning customers, and I had collected enough “points” from them to wipe out the balance. Smacks of desperation does it not?

On Tuesday the Treasury Select Committee interviewed Andrew Bailey of the Financial Conduct Authority (FCA) over the closure of the Woodford Equity Income fund and their regulation of it. It is well worth listening to. See https://parliamentlive.tv/Event/Index/34965022-ec99-4243-8d0b-ae3350c31fe4

It seems that technically the fund only made two minor breaches of the 10% limit on unlisted stocks twice in the UCITS rules which were soon corrected in 2018. But Link were responsible for ensuring compliance as they were legally the fund manager as they were the ACD who had delegated management to Neil Woodford’s company. But in the morning of the same day the Daily Telegraph reported that nearly half of the fund investments were actually illiquid including 20% that were nominally listed in such venues as Guernsey and not actively traded. In other words, they were perhaps technically complying with the UCITS rules but their compliance in principle was not the case. Mr Bailey suggested this is where regulation might be best to be changed to be “principle” based rather than “rule” based but surely that would lead to even more “fudges”? The big problem is yet again that the EU, who sets the UCITS rules, produced regulations that lacked any understanding of the investment world.

The Investment Association has suggested a new fund type be allowed which only allows limited withdrawals, e.g. at certain times or on notice. But that does not sound an attractive option to investors. When investors want to sell, they want to sell now.

Bank of England Governor Mark Carney has said open-ended funds are “built on a lie” in that they promise daily liquidity when it may not always be possible. He also suggested they posed a systemic risk to financial stability. Or as Paul Jourdan said at the Amati AIM VCT AGM: “Liquid investments are liquid until they are not”.

There is of course still no sign that Neil Woodford is taking steps to restore confidence in his funds, as I suggested on June the 5th. There needs to be a change in leadership and in name for that to happen. Once a fund has become a dog and untouchable in the minds of investors, and their financial advisors, redemptions will continue. Neil Woodford making reassuring statements will not assist. More vigorous action by Woodford, Link, and the FCA is required. Affected investors should encourage more action.

The Amati AIM VCT (AMAT) had a great year in the year before last as small cap AIM stocks rocketed but last year was a different story. NAV Total Return was down 10% although that was better than their benchmark index. AB Dynamics was the biggest positive contributor – up 93% over the year with Water Intelligence also up 93%. Ideagen was a good contributor (now second biggest holding) and Rosslyn Data was also up significantly. Accesso fell 36% but they are still holding. I asked whether they had purchased more AB Dynamics in the recent rights issue but apparently they could not as it was no longer VCT qualifying.

I also asked about the fall in Diurnal which wiped £1.2 million off the valuation. This was down to clinical trial results apparently. However, fund manager Paul Jourdan is still keen on biotechnology and pharmaceutical firms as he suggested that healthcare is being revolutionised in his concluding presentation – he mentioned Polarean as one example.

Other presentations were from Block Energy – somewhat pedestrian and not a sector I like – and Bonhill Group which was more lively. Bonhill were formerly called Vitesse Media but are growing rapidly from some acquisitions and clearly have ambitions to be a much bigger company in the media space.

It was clear from the presentations that the investee company portfolio is becoming more mature as the successful companies have grown. This arises because they tend to take some profits when a holding becomes large but otherwise like to retain their successful holdings.

All resolutions were passed on a show of hands vote but I queried why all the resolutions got near 10% opposing on the proxy counts which is unusual. It seems this is down to one shareholder whose motives are not entirely clear.

In summary, an educational event and worth attending as most AGMs are.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Broker Charges, Proven VCT Performance Fee and LoopUp Seminar

The Share Centre are the latest stockbroker to increase their fees. Monthly fee for an ISA account is going up by 4.2% to £5.00 per month with increases on ordinary share accounts and SIPPs also. This is the latest of a number of fee increases among stockbrokers and retail investor platforms. The Share Centre blame the required investment in technology development and “an increasing burden of financial regulation”. The latter is undoubtedly the result of such regulations as MIFID II imposed by the EU which has proven to be of minimal benefit to investors. As I was explaining to my sister over the weekend, this is one reason why I voted to leave the EU – their financial regulations are often misconceived and often aimed at solving problems we never had in the UK.

I received the Annual Report of Proven VCT (PVN) this morning – a Venture Capital Trust. Total return to shareholders was 10.3% last year, but the fund manager did even better. Of the overall profits of the company of £18.6 million, they received £7.7 million in management fees (i.e. they received 41% of the profits this year). That includes £5.6 million in performance fees.

Studying the management fee (base 2.0%) and the performance fee, I find the latter particularly incomprehensible. I will therefore be attending the AGM on the 3rd July to ask some pointed questions and I would encourage other shareholders to do the same. I am likely to vote against all the directors at this company.

I also received an Annual Report for Proven Growth & Income VCT (PGOO) and note that of the 4 directors, 2 have served more than 9 years and one is employed by the fund manager. So that’s three out of four that cannot be considered “independent” so I have voted against them. I would attend their AGM on the same day but the time is 9.30 which is not a good choice and would waste a whole day.

Yesterday I attended the “Capital Markets Day” of LoopUp (LOOP). This is an AIM listed company whose primary product is an audio conference call service. It’s just a “better mousetrap” to quote Ralph Waldo Emerson as 68% of the world are still using simple dial-in services rather than more sophisticated software products such as Zoom and WebEx. There are lots of other competitors in this field including Microsoft’s Skype which I find an appallingly bad product from past experience. Reliability and simplicity of use is key and LoopUp claimed to have solved this with no learning required, no software downloads or other complexities and high-quality calls aimed at the corporate market.

I have seen the company present before and do hold a few shares. This event was again a very professional sales pitch for the company and its product with no financial information provided. Yesterday they also covered the addition of video to their basic conference call service which was announced on the day, plus a new service for managed events/meetings. Video addition is probably an essential competitive advantage that was previously missing. They covered how their service is differentiated from the main competitors which was good to understand.

Last year they acquired a company called MeetingZone which has increased their customer base and revenue substantially and are transitioning the customers to the LoopUp product. Revenue doubled last year and is forecast to rise by about 50% in the current year. Needless to say the company is rated highly on conventional financial metrics and return on capital has been depressed by the cost of the acquisition. But one reason I like this company is that it’s very easy to understand what they do and what the “USP” is that they are promoting, plus their competitive position (many company presentations omit any discussion of competitors).

They also have an exceedingly good sales operation based on groups of people organised in “pods” which was covered in depth in the presentation. These only have team bonuses and the key apparently is to recruit “empathetic” people rather than “individualists”. Perhaps that is one reason 60% of them are female. As I said to their joint CEO, I wish I had seen their presentation some 30 or more years ago when I had some responsibility for a software sales function.

The latter part of this 3-hour event was an explanation of how the software/service is used by major international law firm Clifford Chance with some glowing comments on the company from one of their managers. Customer references always help to sell services.

In conclusion a useful meeting, but lack of financial information was an omission although “Capital Market” days are sometimes like that. But the positive was that they had both institutional investors and private investors whereas some companies deliberately discourage the latter from attending such events which I find most objectionable.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Big Audit Firm Break-Up and Northern VCT AGM

A report commissioned by the Labour Party has advocated the break-up of the big four audit firms that dominate the audits of FTSE-350 firms. The report, co-authored by Prof. Prem Sikka et al, even goes so far as to suggest that their share of that market should be limited to 50% and that joint audits be promoted. In addition it argues that audit firms should be banned from doing non-audit work for the same company, and an independent body to appoint audit firms and agree their remuneration should be set up.

It also calls for the auditors to owe a duty of care to shareholders, not just the companies they audit, which would enable shareholders to pursue litigation over audit failings which they have great difficulty in doing at present. It is surely sensible to reinstate what was always assumed to be the case before the Caparo judgement.

These are revolutionary ideas indeed to try and tackle the problems we have seen in recent years and it seems to be now generally accepted by investors, if not the audit profession, that there have been too many major failings and the general standard is low. Even the Financial Report Council (FRC) seem to accept that view at a recent meeting with ShareSoc/UKSA.

But would breaking up the big four, effectively forcing some larger companies to use smaller audit firms improve the quality of audits? I rather doubt it. In my experience problems with smaller audit firms are just as common as in large ones – it’s just that the big companies and their audit failings get more publicity. Larger firms do have more expertise in certain areas and more international coverage. So there are good reasons to use them. But this report is certainly worth reading because if Mrs May continues to make a hash of Brexit and proves unable to stop dissension within her party we may see a Labour Government looking to implement these policies. See http://visar.csustan.edu/aaba/LabourPolicymaking-AuditingReformsDec2018.pdf . I may make more comments on the report after I have read the whole 167 pages.

Note that this issue of audit firm size came up at the Northern Venture Trust (NVT) Annual General Meeting which I attended today. This is a long-established Venture Capital Trust – it was their 23rd AGM, many of which I have attended. One shareholder voted against the reappointment of KPMG on the “show of hands” vote, and there were 1.2million votes against them on the proxy counts (versus 10.9 million “for”). It is unusual to see so many voted against such resolutions. When I asked the shareholder why he voted against I was told it was because he thought that a smaller audit firm might do better as VCTs are relatively smaller investment companies. However I pointed out that VCT legislation is very complex so it makes sense to use an audit form that is more knowledgeable in that regard.

The other possible reason for high proxy votes against the auditors is that Nigel Beer, who chairs the Audit Committee is a former partner in KPMG although he told me later that he had departed many years ago. Anyway I did raise this issue in the meeting and the fact that both Nigel Beer and Hugh Younger had just passed 9 years of time on their board. In addition, Tim Levett, who is Chairman of NVM, the fund manager, is on the board. So according to the UK Corporate Governance Code that’s three directors out of 6 who should be considered non-independent.

I urged the Chairman to look at “refreshing” the board although I did not doubt their experience and knowledge. It was also pointed out to me after the meeting that there are no women on the board. So effectively this is really a stale, male, pale board. However the Chairman said they do regularly review board structure and succession.

Other than that there were some interesting comments given by Tim Levett in his presentation. He said that due to the change in the VCT rules in 2016 they have changed from being a late stage investor to being an early stage one. In the last 3 years they have built a new portfolio of 22 early stage companies and are probably the most active generalist VCT manager other than Titan. NVM have opened a new office in Birmingham and built up the Reading office. There were also a number of new staff who were introduced at the meeting.

He also said that like all the top 10 VCTs, an awful lot of special dividends had been paid in the last three years. This was because of realisations and the VCT rules that prevented them from retaining cash. This has meant a reduction in the NAV of the trust but in future they will try and maintain that at the same time as maintaining a 5% dividend. Note: that historically it means that capital has been paid out in tax-free dividends that investors might have reinvested in the trust and hence collected a second round of up-front income tax relief. One can understand why the trust does not want to continue doing that as it may otherwise spark some attention from HMRC. I also prefer to see VCTs maintain their NAV as otherwise the trusts shrink in size which can create problems in due course as we have seen with other VCTs.

NVT are doing a new share issue in January which will of course improve their NAV and I was glad to hear that at least some of the directors will be taking up shares in the offer and adding to their already considerable holdings. That inspires some confidence that they can cope with the changes to the VCT rules that mean there will be more emphasis on investing in riskier early stage companies.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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British Smaller Companies VCT Offer

It’s that time of year when share subscription offers for Venture Capital Trusts (VCTs) tend to be launched. One of the first is that for the British Smaller Companies VCT (BSV). This one that has shown a relatively good performance for a generalist VCT – share price total return of 225 over ten years according to the AIC compared with a sector performance of 136. It also has a high dividend yield and a narrow discount to NAV. However I have never liked their manager’s performance incentive fee arrangement and consistently vote against the Chairman, Helen Sinclair, who introduced it. But they are proposing to change it.

Currently the incentive fee is based simply on dividends paid – at the rate of 20% of those paid – so long as a dividend hurdle is met. There is also a hurdle for Net Asset Value (NAV) which has to be met, which presumably was intended to ensure that the NAV did not fall to too low a level. However, very high dividends can be paid by the company even though the company has lost money on many of its investments. In effect, dividends can be paid out and incentive fee based on them paid to the manager even though the company’s earnings do not cover the dividends. Incentive fees based on dividends paid out in VCTs are simply wrong.

What can happen is that dividends are paid out based on realisations, while ignoring the unrealised losses in the portfolio. This arrangement resulted in a very large incentive fee being paid to the manager in 2017 – dividends of 22.0p paid out when reported earnings were only 4.6p. The result was total management fees of £5.5 million paid when assets at the start of the year were only £96 million.

What is the new management fee arrangement? In essence it will remain dividend based with the same 20% figure. The only change is to introduce a Total Return hurdle to replace the Net Asset hurdle. There are other changes and complications to the incentive agreement which are very difficult to understand, including an overall cap, for which you need a spreadsheet to understand the effect. But the company says “Note that the historic incentive payments would have been significantly lower if the proposed incentive arrangements had been in place since 2009 due to this cap”. I’ll take their word on it, but it’s still a bad arrangement and should be simplified.

There is also going to be a reduction in the fixed “investment advisor fee” of 2% of assets so that only 1% is paid on cash balances held.

Shareholders may wish to vote for these changes as they may be better than the past arrangements but I suggest shareholders write to the Chairman as I shall be doing and complain that the board needs to try harder. This looks like an agreement that has been written by the fund manager. Incentive schemes for fund managers should be simple to understand by shareholders and the board, and not based on dividends paid out but on total return.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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