ICAP AGM 2011

icapital.biz held its FY2011 AGM yesterday at the KL Convention Center. icapital.biz is a closed end fund of Malaysian stocks managed by Tan Teng Boo.

This year's main issue during the AGM was whether buy back shares of the company due to its persistent undervaluation by the market since the global financial crisis (it has been trading at a discount of around 20% to its nett asset value.) As  Warren Buffett has announced that Berkshire Hathaway intends to buy back shares for the first time in its history, icap has also been evaluating this.

The investors were given a presentation of the pros and cons of a buyback. From their  analysis, a share buyback followed by cancellation of the shares will only have at most a 2% effect of increasing its NAV. In Malaysia, the maximum amount of share buyback is 10% of the shares. A share buyback may temporarily reduce the fund's undervaluation but there is no guarantee that this effect will be long-lasting since the buyback is a one time event. This has been proved by some case studies research in the US.

The other option would be to sell the shares later after the price goes up. This is not good either but I forgot what was their reason (because I did not take notes)... I think it was because this action is unfair to the long term investors in the fund. Maybe it is like giving some of the cash to those who want to opt out of the fund later at the expense of others. Also, the anticipation that the shares will be sold later will depress the price of the fund. To me, it doesn't seem ethical for the fund to do so, as it would penalize those who sold at below NAV either out of desperation or ignorance.

But then, if done at a continued basis, it could serve as a stabilizer to ensure the fund always trades near its NAV. Imagine such a policy being announced, then on the next trading day nobody would sell at below NAV (assuming everybody was well informed). The only sellers are the traders who think the price will go down more. Similarly nobody would sell above NAV except traders. This however may be impractical due to the 10% limit. And maybe it will lead to potential manipulation?

A share buyback will reduce the cash balance of the fund (by about $30m to $85m, my estimate based on its annual report.) That will reduce the ammunition the fund has to buy some cheap undervalued stocks when the opportunity arrives. This is the option preferred by the fund manager.      

The fund's analyst (all their analysts sound and look like fresh university graduates) also highlighted the difference between a company and closed end fund share buyback. If a company buys back all its shares, its taking itself private but its business still continues to generate profit for the company. When a closed end fund buys back shares, it is amounting to liquidating itself.

As a comparison, Berkshire has traded at a premium which has reduced over the years until now it is near 1.1x NAV. Warren Buffett recently announced they will buy back shares at below 1.1x NAV. No one seems to be sure of his reasons, perhaps he is just trying to signal his confidence in the US economy. 

The other issue, which always crops up, is the request to pay dividends. The manager says a firm no to this as it is against the fund's original objective.

To be noted, local retail investors have been selling the fund (based on the decreasing number of shareholders) but some foreign investor have been buying in the past year. 5 foreign investors are among the top 30 largest shareholders.

Well, whatever action taken it depends on the objective. If you want to cash out, then you would want the fund to buy back so you can sell at close to the NAV (or you hope many new investors will come in so that the discount starts decreasing). If you believe in long term capital appreciation, which is the objective of the fund, then you prefer the fund use its cash to buy more undervalued stocks later (and you buy more of the fund while its at a discount). If you want to wait and see, then you wait for the fund to trade at a premium and then consider selling (but when that happens, you'll probably hesitate, right :P)