Back to the Future
One of the great challenges in any industry is finding a “New Model,” or dramatically better way to provide a service or product.
Within the U.S. investment industry, there has been a shift from mutual funds to more flexible “hedge funds.” Both of these structures have inherent problems. Mutual funds are caught in a continual quest for short term performance, suffer redemptions during low markets, or have the structural inflexibility of having to stay within a specified category of investments. Typically, hedge funds are limited to larger investors and have restrictions on liquidation, as well as a certain lack of visibility as to their underlying holdings and management.
The closed-end investment company or publicly traded corporation provides the most efficient and flexible means of accumulating wealth. This structure harkens back to the first half of the last century when numerous closed-end investment companies created significant wealth for their shareholders.
Over the years, closed-end investment companies fell into disuse as many traded at discounts to their underlying asset value. That was more the case with stagnant or passive holding companies than with actively managed organizations. Within our definition, Berkshire Hathaway Inc., for example, would qualify as a closed-end investment company, which is actively managed and trades at a premium to its underlying asset value.
Another criticism was that closed-end investments were tax inefficient, since corporations have to pay their own tax. This can actually be an advantage for private shareholders, or taxed accounts, who seek simplicity in their financial affairs. Tax inefficiency can be overcome with greater operating efficiency, such as the use of leverage, non-taxed dividend flow-throughs and the ability to be flexible as to asset mix. Tax considerations should never outweigh operational advantages. Wherever there are accumulated corporate tax losses, this objection is negated.
Surpassing the above points are the significant positives emanating from the use of a publicly traded company as a medium for a wide range of investment activities. A partial list is as follows:
- Managers are able to take a long view in order to achieve results. For mutual funds, quarterly performance demands can undercut strategic investing.
- Asset mix can be more attuned to market conditions. There is a time to be in the stock market and a time to simply hold cash. Fixed income holdings can be altered and maturities shifted to capitalize on opportunities in the bond market. Mutual fund managers must stay heavily invested in the specific type of securities within the mandate of their specific funds. Asset shifts by investors from one mutual fund to another are reactive, rather than in anticipation of events or in order to make profit. The combination of inflexibility with after the fact changes can be very costly.
- Leverage (borrowing) can be used to overweight a sector or security which appears attractive. This is, of course, a double-edged sword which can have both advantages and disadvantages. There is, however, the flexibility to capitalize on opportunities and enhance results. Options can also be used, when advisable. In the above cases, the investor has his or her risk limited to the amount of the investment in the closed-end investment company.
- The capital invested in a closed-end investment company is stable. Mutual funds lose their resources through redemptions in depressed markets and regain them as a result of investor purchases toward market tops. In short, funds gain or lose cash resources at the worst possible times. This can impact longer-term performance.
- “Short” positions can be implemented by closed-end investment companies when potential declines are identified and again, with limited liability for the individual investors.
- There is increased scope to participate in various investment products from real estate, to private companies, to venture capital opportunities.
- The capital structure of a closed-end investment company can be structured using bank borrowings, bonds, zero coupon bonds, convertibles, preferred shares and common shares to provide greater and more focused benefits to investors.
- Greater liquidity exists. If an investor wishes to liquidate his or her holdings, then a simple sale can be initiated on a stock exchange through any broker. Often, with mutual funds, there is a tendency for the Investment Advisor to want to continue holding because of trailer fees. The variance of the stock price from the underlying asset value also provides trading opportunities.
- Overall efficiencies are greater in a closed-end investment company, since operating and transfer costs are reduced. Investment Management costs can be higher or lower, depending on the specific management contract in place. At least, a greater proportion of expenses is used to achieve results, with the manager’s compensation more closely aligned with performance.
Urbana Corporation has the flexibility to invest across a wide spectrum of investment possibilities. We are of the opinion that market volatility and the rapidly changing economic scene will present both opportunities and risks. It is therefore incumbent upon investors to have a full range of alternatives available in one vehicle, in order to avoid pitfalls and to seize opportunities on a timely basis.
Urbana Corporation is utilizing the facilities of Caldwell Investment Management Ltd. and Caldwell Asset Management Inc. to aggressively manage the company’s marketable investment portfolio on a 1% fee basis and a 20% participation in net portfolio gains.
Caldwell Investment Management Ltd. and Caldwell Asset Management Inc. (“Caldwell”) and their affiliates have managed investments for high net worth private clients and institutions since 1981.
Caldwell ‘s disciplines combine a “top down” economic and financial market overview with a “bottom up” analysis of specific companies which fit within this broad analysis.
Over the years, the Caldwell team has demonstrated strength in identifying changes in price and market trends ahead of many other market participants and commentators.
The primary difference between this aggressive trading entity and the main body of Caldwell ‘s managed accounts is based upon Urbana ‘s use of leverage and aggressive positioning to capitalize on their market views and analysis. The asset mix of bonds and equities can vary significantly, as can the currency and nature of the investments used.
The term “Hedge Fund” is often used to describe the above. We do not anticipate “hedging” or offsetting positions to counter risk exposure. Caldwell ‘s technique utilizes market volatility in order to benefit from focused positioning.
The nature of this trading style has risk and, as such, investors must be “qualified” as to net worth and experience. Risk can always be contained within a portfolio by restricting investment to a small portion of one’s overall holdings.
Success in aggressive investing depends upon correctly forecasting the trend, picking the sector and then selecting the individual securities to be used. Among these three factors, anticipating the overall market trend is the most critical. If one does not correctly perceive the general trend, sector and individual stock selection become significantly less relevant in achieving results. This has been clearly illustrated over the past few years.
Caldwell has been using this levered model for Urbana Corporation since September 30, 2002 with the results as indicated in the attached Performance Appendix. One should be cautious in extrapolating performance numbers into the future. In September 2002, Caldwell correctly took positions near the market bottom of October 9, 2002 . They also correctly selected the money-centre banks and telecom equipment groups. As much as we would hope, they are not going to hit home runs each time at bat.
Thomas S. Caldwell and Caldwell Financial Ltd. own just under 50% of the outstanding shares of Urbana Corporation. Caldwell Financial Ltd. has also provided financing to Urbana Corporation in the amount of $1 million, convertible into shares of Urbana Corporation on an escalating scale from $0.30 per share. Exercise of the conversion would place Caldwell Financial Ltd. in a majority share position.
Thomas S. Caldwell
Urbana Corporation (Symbol: URB)
Listed on the Toronto Stock Exchange Venture Exchange