Beaufort Settlement Improved, But…..

It’s good news that PWC have revised their proposals for the administration of Beaufort and the return of client assets. No doubt due to the efforts of ShareSoc and others. But it still leaves many issues that need properly tackling. These are:

  1. The Special Administration Regulations that allow client assets to be used to cover the costs of the administration. Client assets should be ring fenced and they are what they are called – client assets not assets of the broker or bank.
  2. The fact that most investors now have to use nominee accounts and they are therefore not the legal owner of the shares they hold. We need a new electronic “name on register” system and the Companies Act reformed to reflect the realities of modern share trading.
  3. The UK needs to adopt the Shareholder Rights directive as intended, so that those in nominee accounts have full rights. The “beneficial owners” are the “shareholders”, not the nominee account operator.

We must not let these matters get kicked into the long grass yet again due to the reluctance of politicians and the civil service to tackle complex issues.

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

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GKN and Melrose – The Reality

Melrose has won the battle to take control of GKN although the Government might yet step in to halt the takeover. On what grounds is not exactly clear. Never having held shares in either company, I thought it worth looking at the facts rather than the hyperbole surrounding this deal as there seemed to be some myths being propagated.

Is GKN a key business in the UK’s engineering and technology infrastructure based on a long history of innovation? Or is it a financially poorly performing conglomerate that was vulnerable to a bid?

It has been said that GKN produced Spitfires in the Second World War but in reality they did not develop the plane but were just one of several assembly plants that were subcontracted to produce it in volume, In the 1960s I well remember the company under the name Guest, Keen and Nettlefold and in Birmingham they had large factories producing nuts and bolts. Hardly high-tech engineering even at that time. Later they did make a success of car parts production particularly with constant velocity joints (CVJs) as used in the Mini and other front wheel drive vehicles. But they are now proposing to split off the driveline business and merge it with another company. They plan to focus on the aerospace business. You can see a “polished” version of the history of the company here: https://www.gkn.com/en/about-gkn/history/ . In reality a long history of dubious diversifications, followed by later rationalisations.

The recent financial performance has been disappointing. Reported earnings per share in 2017 were the same as five years previously with a trough in between. Dividends in that period grew slowly and at the current share price equate to about 2% yield. Return on assets a measly 5.6% last year, and even that was an improvement on previous years. Although the financial prospects based on analysts’ forecasts might be slightly improving, is it not simply a case that institutional investors might have become disillusioned with the management in recent years and seen an opportunity in the Melrose bid to improve the financial returns?

There will no doubt have been some activity by share traders, arbitrageurs and hedge funds of late who might have influenced the outcome. But that’s capitalism in action. Holders, even long-term ones, sell to higher bidders.

Personally I oppose any suggestion that short-term holders should not be allowed to vote, and the use of other “poison-pill” mechanisms that can defeat takeovers. If I purchased a share in a company last week, I want to be able to vote it! I may not have known that a bid was coming and how I vote will depend on the arguments put by both sides. Clearly in this case GKN simply lost the argument.

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

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Aviva Preference Shares – FCA Announcement

Readers who take any notice of financial affairs will be aware of the furore over the threat by Aviva to redeem their preference shares by a “share cancellation” process – they claimed that is a different legal process, even though the shares were described as “irredeemable”. The shares concerned dropped in price to a significant extent because their high coupon interest rate meant they were trading at a premium when cancellation would have meant redemption at the original par value. Aviva have reconsidered the matter, but the interesting aspect today was a response from the Financial Conduct Authority (FCA) to a letter from the Treasury Select Committee. You can read it here: https://www.investegate.co.uk/financial-conduct/rns/fca-response-to-tsc-on-aviva-plc-preference-shares/201803280704471964J/

It basically gives lots of reasons why they cannot yet respond to some of the questions as they are still looking into the issues, but in response to Question 4 they seem not to concede that they should be involved in “the resolution of the legal questions”. In other words, they would be quite happy to leave it to an enormously expensive law suit by investors to resolve the key questions.

They do not seem to accept that they have an overriding objective to ensure a fair market for securities and that investors should not be prejudiced by small print, concealed or opaque legal terms and other sharp practices.

The response to Question 6, seems to try and excuse the problem by saying the shares were issued more than two decades ago and the FCA has taken subsequent action “in order to restrict the retail distribution of regulatory capital instruments….”. This is surely not an adequate excuse. The shares concerned were and are publicly traded and there is nothing stopping any investor (at least a “sophisticated” one) from trading in them. But even sophisticated private investors and some institutions were caught out by the unexpected threat from Aviva.

The FCA is again proving to be toothless in the face of seriously unethical practices. In other words, they are not doing their job competently and should be reformed in my personal opinion. I believed the FCA adopted an objective of more “principle-based regulation” a few years back but now seem to have abdicated that responsibility and are quite happy to let lawyers argue over the wording of a prospectus while ignoring the ethical issues. Just as they did with the RBS and Lloyds cases. It’s simply not good enough to issue the kind of response they have to the Treasury Select Committee.

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

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Libel Settlement – Peace Breaks Out

Some readers of this blog may have become aware that I was pursuing a libel action against Tom Winnifrith of ShareProphets. Tom writes a newsletter which many private investors read, and he often tackles the dubious activities of some public companies and their directors – particularly AIM companies – which can only be applauded.

Our legal dispute has now been settled and Tom has withdrawn his allegations to my satisfaction. He is in the process of removing them from the web. He has even gone so far as to call me an “underlying good person” in a recent podcast so I am feeling quite saintly at present. I hope readers will not hear more about this matter.

The following statement was agreed by both parties as part of the Settlement Agreement.

Roger Lawson & Tom Winnifrith: a joint statement

Roger Lawson and Tom Winnifrith have agreed that Mr Lawson’s legal action against Tom Winnifrith for libel will not be pursued further. Life is too short. Both men are agreed that nearly all of the work done by each other on seeking reform of AIM and in campaigning against poor corporate governance is worthwhile. There are too many ways in which the stock market needs reform and too many individuals who break the rules that do exist, for energies and money to be wasted on a fight that will enrich only lawyers. 

Tom Winnifrith stated: I stand by my assertion that Roger Lawson should have declared ownership of shares when writing about them at all times and it would have been better practice to have advised readers to sell before doing so himself. But Roger acted in line with the rules for the ShareSoc blog and other publications. More importantly I am sure that he did not act in the way he did in order to secure personal financial gain. Nor did he secure a gain as a result. Roger can be somewhat cantankerous but his heart is normally in the right place; he is not the sort of man I want to be fighting, especially as on most issues we are in agreement. My energies should be focussed on the bad guys and Roger is not one of them. 

Roger Lawson stated: Like most people I find Tom Winnifrith’s language not always to my liking. However on most occasions when he goes after a company his judgement is shown to be correct and in doing that he performs a valuable service. In publishing the Globo dossier he showed bravery other journalists baulked at and with hindsight he asked all the right questions of blinkx and Globo. Since we agree on far more than we disagree on it is right that instead of making lawyers rich with any law suit we both move on and continue to offer fair criticisms of the London market and to fight on behalf of ordinary investors.

<End>

Part of the dispute was about the fact that I sometimes commented on shares that I owned. That continues to be the case on this blog, although I frequently comment on shares that I have never had any financial interest in whatsoever (for example Autonomy in my last blog post simply from my knowledge of the IT world). Excluding shares that I have owned would not make sense as I often have a deeper understanding of those companies than any financial journalist could quickly acquire. Readers should read the About page on this blog to understand the legal terms that apply to the content and use of this blog which covers that point, although I would normally declare any interest in shares when I write about them.

Postscript: Readers are reminded that I never give buy or sell recommendations on shares, and have never done so in the past. I try to give a balanced view about companies so if I point out positive aspects I am likely to also include the negative aspects. A good example is my recent comments on Rightmove Plc. Whether my comments are fair and accurate at the time you will need to judge for yourself, and hindsight can distort the picture. I am generally dubious about the ethics of those who comment negatively on companies in public while shorting the shares and likewise I do not appreciate those investors who puff shares they hold – even institutional fund managers are frequently guilty of “talking their own book” which I consider a dubious practice. It is unfortunate that the ethics of the financial world leave a lot to be desired and “fake news” is a growing problem.

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

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Autonomy Legal Case and Revenue Recognition

There is an interesting report in today’s Financial Times on the legal case against the former CFO of Autonomy. Leading British software company Autonomy Plc was acquired by Hewlett Packard for $11 billion but subsequently had to write it down by $5 billion. They alleged that Autonomy had inflated the value of the business by various accounting practices and that is now the subject of a civil law suit.

But the interesting aspect is that the former CFO, Sushovan Hussain, is facing a criminal court today in California for 15 counts of conspiracy and wire fraud associated with the alleged falsification of Autonomy’s accounts. The UK’s Serious Fraud Office did look at the case but dropped it in 2015.

Mike Lynch of Autonomy has vigorously denied the allegations and has even set up a web site to defend himself and others against the allegations. You can read his side of the story here: https://autonomyaccounts.org/

But for investors the FT article gives a nice list of the abuses that are alleged and are common in software companies. They include:

  • Booking transactions to resellers as revenue when there was no end-user license (i.e. “channel stuffing” as it is sometimes called).
  • Engaging in “round-trip” transactions where purchases were invented so it could pay money to companies which then returned it to Autonomy to cover fictitious sales.
  • Backdating sales transactions so they fell into a previous accounting period.

There is also a claim previously reported that bundles of hardware/software sales were treated as solely software in the accounts. Why does this matter? Because software sales are valued in company valuations much more highly than hardware sales.

The above are some of the things that investors in IT companies need to look at although abuse can be difficult to spot in the published accounts of a public company. High accounts receivable and apparent lengthy payment delays can be clues. There were some questions raised about Autonomy’s accounts even before the takeover.

One claim by Autonomy’s founder, Mike Lynch, is that some of the disputed differences are simply down to different accounting standards (US GAAP versus IFRS), but I am not sure that stands up to scrutiny.

Hewlett-Packard are effectively saying they were sold a pup, while Autonomy executives deny wrong-doing and blame HP for not reading their due diligence report carefully, screwing up the subsequent integration and then searching for a scapegoat after what turned out to be a disaster of an acquisition.

But if the SEC’s California prosecutors make the charges stick then there may be more problems for Mike Lynch.

The auditors of Autonomy were Deloittes.

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

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The Art of Execution – Essential Reading For Investors

I am an avid reader of newsletters and the national press on investment matters and noticed a couple of writers recently mentioned very positively the book “The Art of Execution” by Lee Freeman-Shor. I have now read it myself and it’s definitely a book every stock market investor should read. Here’s why:

There are thousands of books available on investment, aimed at both neophyte and experienced investors. They tend to fall into two main groups: those teaching you how to pick out good investments and those explaining how successful past investors have operated. Incidentally reading the latter ones simply tells you that there are many different styles that can be successfully used. But the main problem with the former approach alone, as the author points out, is that even with the most expert fund managers (and the most highly paid), only 49% of their “best ideas” made money when he analysed their performance.

Mr Freeman-Shor managed investors in his role as a fund manager at Old Mutual Global Investors and studied all the deals they did over seven years. Some investors made money for him overall but others did not, and the main differentiator was how they reacted to various circumstances, not their skills in initial stock selection.

Every investor faces decisions. When your favourite stock, where you have a big holding, drops 20% do you cut your losses and sell, or buy more? When another stock rises by 20%, 30% or more do you sell it to realise profits in fear of it falling back? Or do you buy more? Or perhaps you sell some and keep the rest (“top slicing” as it is called)? Do you worry when your portfolio ends up with 40% or 50% in one or two holdings?

Many investment gurus tell you to use a “stop-loss” to avoid big mistakes, but Freeman-Shor explains that many successful managers actually bought more if they believed in the fundamentals of a company. Clearly there is more to this subject of successful execution than the simple rules advocated by many. What really differentiated the successful investors is not how good they were at picking out winners, but how they managed their holdings later. He identifies a few distinct styles which differentiate the winners from the losers.

One of the handicaps of professional investors the author identifies is their unwillingness to take risks in case they get fired for short term underperformance. So they tend to over-diversify and take profits too early. These are bad habits that private investors can avoid.

There is much in this book that I have learned myself from 30 years of investing. But the author identifies the key habits and investment styles than can be successful. Essential reading for any new investor and highly recommended. And also interesting for those already experienced.

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

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KIDS – Who Is Kidding Who?

There was an interesting article published by Citywire yesterday on the subject of Hargreaves Lansdown removing 96 investment trusts from its trading platform. Such trusts as Dunedin Enterprise, Blue Planet and Oryx International Growth have been suspended. The reason is because they have not yet made available a “KID” (Key Investment Document) which is required by the new PRIIPS regulation and mandated by the FCA/EU from the start of this year (see https://www.fca.org.uk/firms/priips-disclosure-key-information-documents for more information).

At present investment trusts are mainly affected. Unit trusts and OEICs that are UCITS have another two years to comply.

The Citywire article quoted Annabel Brodie-Smith and Ian Sayers of the AIC (trade body for investment companies) as saying it was only a transitional problem but that the mandatory performance figures in the KID “will in some cases, be suggesting too favourable a view of likely future performance” and the “single-figure risk indicator will potentially be understating the risks”. Mr Sayers has also criticised the fact that open-ended funds will not need to disclose underlying transaction costs when investment companies will need to do so, thus making comparisons difficult.

Investment Trusts are of course a peculiarly British investment platform whereas most of Europe use open-ended funds, and hence the legislation was focused more on the needs of the rest of Eurupe rather than the UK. The UK already had quite extensive disclosure of fund information, particularly for investment trusts which was published in such documents as a “Monthly Factsheet” with performance date readily available from the AIC web site, Trustnet and other sources.

I posted a comment on the Citywire article which said: “The regulations impacting investment trusts are a typical example of EU laws written by folks who do not understand the UK market environment, and are also generally ignorant of the financial world. The sooner we depart the better. Expensive and incompetent bureaucracy in more ways than one.”

That immediately prompted the usual abusive comments from EU lovers – anonymously of course. A vigorous debate then followed. So what is the truth? Are KIDs going to be useful? Were some trusts deficient in being up to speed on making KIDs available? Is the additional expense of producing a KID worthwhile?

Now it is undoubtedly the case that some investment trusts might have been tardy in meeting the regulations (although I believe Dunedin Enterprise Trust is winding down so they might have not put a high priority on it). But as it will prevent purchases but not sales, this needs to be rectified as soon as possible otherwise prices might be distorted.

But are KIDs useful? You can see one for JPMorgan Euro Smaller Companies Trust (a trust I hold) here: https://documents.financialexpress.net/Literature/83197092.pdf ). The risk rating is simplistic and the “performance scenarios” are likewise. It shows that over 5 years a holding in this trust might generate a negative return of 18.62% per annum, but in a “favourable scenario” you might make 36% per year. Does that help you? Not a lot.

That is particularly so as those figures are forecasts, not the real historic data. In comparison the information on the AIC web site or the company’s web site, including in the company “Factsheet” is much more comprehensive and more helpful. For example, it tells you about the historic price performance versus the net asset value performance (and over several time periods), the discount levels, the performance against a benchmark and lots more data.

The KID does have some useful information on costs, as it includes transaction costs. As a result it gives the “Impact on Return” due to costs of 2.81% per year whereas the AIC reports an “On-going” charge of 1.13% for this company because they don’t include transaction costs. This is a company that does not have a performance fee though which would complicate reporting on other trusts.

The objective of the KID to standardise the reporting of basic information on investment funds, and provide consistent and accurate “all-in” cost data was laudatory. But the implementation is a dog’s breakfast with the result that investors are hardly likely to spend a long time looking at these documents even if they are forced to do so.

On the latter point, the Share Centre now require you to tick a box to say you have read the KID before buying the shares, but other platforms such as AJ Bell YouInvest don’t seem to require that. I suspect folks will soon learn to tick the box regardless simply because most investors will have done some research on the fund, or already hold it (perhaps on another platform).

In summary, KIDs are designed to meet the needs of unsophisticated pan-European investors where little information might have been available to them previously. Whereas in the UK we are awash with information on trusts and open-ended funds to the point that a lot of investors are suffering from information overload. The KID just adds to it.

The information provided in the KID can be grossly misleading about the risks and returns that investors might expect. The document is the end result of the complex bureaucratic processes in the EU for devising new financial regulations, where those developing them seem to have little understanding of financial markets or investment and the end result is often a compromise between different national interests. The process is also heavily influenced by the large financial institutions such as banks that dominate the retail investment scene in much of Europe.

Financial regulation in the UK is not perfect of course, and we have the same difficulties that they are often written not for the benefit of investors but for market operators and intermediaries. We might just be able to do better. But we also need to push for improvements to the content of KIDs because we may still need to produce them to enable trading of investment trusts and funds across Europe.

It is though unfortunate that the cost of producing a KID will be significant and will be passed on to investors. Likewise the MIFID regulations brought in on the same date have resulted in major costs for stockbrokers. More regulation costs money and investors do not always benefit from it. One particularly disadvantage is that it deters new entrants into the investment world, i.e. protects the interests of the big boys from more competition. Financial regulations when devised need to be simple and low cost to implement and enforce. That is a long way from being the case at present. The PRIIPS regulations are a good example of how not to do it.

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

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