Fund exit a timely lesson to tread with care

Merricks Capital has some explaining to do after removing itself from a listed fund, writes Brian Robins.

An investment management company backed by Melbourne's Liberman family has quit its management of a publicly listed investment company after losing millions of dollars of investors money.

In presentations to investors, Merricks Capital warned clients about investing in "anything you don't understand", although since it took management control of the listed Merrick Special Opportunities Fund, which was formerly the Fat Prophets Australia Fund, it has put a large part of its funds into a copper and gold miner which has nearly destroyed the company.

If investors need reminding that even listed investment companies must be treated cautiously, this is it.

With the market posting strong gains over the past two quarters, the prices of some listed investment companies has risen significantly, with some now trading at premiums to the portfolio of shares they hold.

Others remain at stubborn discounts to book value.

This was one reason why Premium Investors opted to merge with fund manager Geoff Wilson's WAM Capital. With the shares trading at a steep discount to their asset backing, a merger provided one way of closing that gap, with shareholders becoming part of a larger, more liquid, investment company.

Another listed investment company, Peters MacGregor Investments, decided to go down a different path and wind itself up. It is moving to delist its shares from trading, liquidate its investments and return all funds to shareholders.

At another listed investment company, Emerging Leaders, some restive shareholders recently moved to dump directors at the same time as another director, fund manager Paul Xiradis, opted to spend over $120,000 of his own money to raise his stake in the company.

So far, shareholders have been left in the dark as to what is going on, although the manoeuvrings are yet to help close the discount to asset backing the shares are trading at.

For the most part, listed investment companies hold shares in other listed entities, giving shareholders a diversified investment portfolio through a single holding.

With a market capitalisation of $5.7 billion, Australian Foundation Investment Co gives shareholders exposure to a range of blue chip companies, while Contango Capital, worth $160 million, holds small and microcap stocks.

And this was also the case at the Fat Prophets fund when Merricks Capital gained the right to manage the fund in March 2010. At that time, its broadly based portfolio gave the shares a net asset backing of $1.15.

Subsequently, Merricks Capital liquidated the fund's share portfolio, putting the money raised into risky investments, with the asset backing now estimated at just 60¢ and the shares last traded at 40¢.

Not only has the share price collapsed since management changed, but investors have also missed out on the market's subsequent gains.

Select Asset Management has 8.2 per cent of the shares and fund manager Geoff Wilson has sold down his holding of 5.25 per cent. It is unclear what the level of his holding is, although late on Thursday his investment funds requisitioned a shareholder meeting to force out Merricks representatives or their appointees from the board.

Directors came under fire at the annual meeting last year over the poor investment performance, although shareholders were told they could not easily dump the fund's manager, with the only possibility being when the fund had underperformed the S&P/ASX 300 Accumulation index by 15 per cent over three years.

"As is the case with most externally managed listed investment companies, there is virtually no scope to terminate the management contract . . . before its expiry unless there has been some form of uncorrected abrogation of the contract or mandate by the manager. This has not occurred," the chairman, Andy Brown told shareholders.

Now, with the three-year underperformance clause about to be triggered, Merricks has called it quits as the fund manager and also sold its 13 per cent stake in the company.

"This was voluntary," Merricks Capital chief executive Adrian Redlich said of the decision to surrender management of the fund. "We've suffered the biggest loss."

Even so, he refused to clarify the price at which Merricks sold its 13 per cent stake, citing a confidentiality agreement with the purchaser, Andrew Barnes, who now has 20 per cent of the shares.

And despite any losses, Merricks received sizeable management fees annually, pocketing $350,000 in the latest financial year alone.

Apart from some cash holdings, nearly all of Merricks listed fund's capital is tied up in miner Straits Resources and in Lantern Hotel Group, the former IEF Real Estate Entertainment.

"The ethos of Merricks Capital is to provide absolute returns by making investments only in areas where Merricks Capital has an informational edge which is driven by fundamental research and analysis," the Merricks website claims.

"All of Merricks Capital's investment ideas are generated by detailed bottom up fundamental research by analysts who have specialised industry and sector knowledge and experience."

But as shareholders in the fund now know, this was not the case, leaving the chairman some explaining to do.