Gold Investing - A New Alternative

Richard Kovacs, Executive Chairman GoldLink Capital.
Interview with Michael Pascoe, 10th October, 2005

Over six years our annualised performance is 24 odd percent per annum. So strong performance there together with paying our regular dividends to shareholders. The vehicle that pays these dividends is known as GoldLink Income Plus. It’s now a listed vehicle, it listed in December 2003. We’ve paid approximately 13 dividends to date on the half year and a few special dividends. All of those dividends have been fully franked. The dividend yield has been approximately 10 percent per annum and we’ve also been providing capital growth to investors during that time.

Michael Pascoe (MP): And you’ve also just moved to a quarterly payment of dividends, the GoldLink income fund, so you really are targeting self managed super funds, retirement funds.

Richard Kovacs (RK): We have, we’ve done that partly in response to the new international accounting environment which does increase the volatility of earnings so what we sought to do is to increase the frequency of providing for dividends such that should you not be able to pay a dividend in one period, you can certainly make up for it in subsequent periods. We find that our investors like regular dividends rather than waiting for two times a year dividends. The possibility of 4 dividends a year is quite compelling to our investors and that’s resonated quite well. All our dividends are fully franked and so they can make good use of those franking credits.

MP: Now the hard part for your investors is to understand how you make the money. You’re an absolute return fund, a hedge fund, operating in gold. Can you explain in English what you do.

RK: It is somewhat complex. It’s not just like buying gold shares. It’s not like buying gold and having the gold price goes up. We take positions in the market, which benefit from both a rising and falling price environment. Most of our positions are in Australian dollars so we’re not just playing the US dollar gold market. We’re primarily playing in the Australian dollar gold market sense. We utilize financial instruments known as over the counter contracts. These are specialized contracts that are established between ourselves and our investment banking counterparties. They’re specialist instruments. They’re tailor made. They’re structured investments over a long period of time. They’re investments which have maturities up to 10 years and they’re quite innovative in that context.

MP: And they are what? They’re options over gold, selling and buying.

RK: Yes indeed. They’re both option contracts and forward contracts so we have both options where we buy and sell option contracts both short term and long term and we also engineer short and long term forward contracts.

MP: So you’re turning a trick on an arbitrage basically on long and short prices in gold.

RK: In part yes. The way we’ve structured our.. those financial instruments, those forward options is designed to participate in volatility in the gold market specifically and we like volatility in a sense where the gold prices goes up and down in an Australian dollar gold price context but also when what is known as volatility levels increase. And that also enhances the value of those option contracts that we put in place. In a sense what we’re also doing is leveraging off the very large amount of gold that is sitting in central bank vaults around the world. Central banks have a willingness to lend out part of that gold to the professional market being the highly rated investment banks and we in turn borrow from those investment banks at a very low gold borrowing rate. Much lower than the prevailing interest rate and we are able to convert that gold into cash and benefit from higher interest rates, high cash interest rates and so therein crystallise the difference between the cost of borrowing gold and the costs of investing all the interest income which can be generated from investing the proceeds from that gold into the prevailing money market rate which can be a lot higher.

MP: We did hope for English. We nearly got there. Big returns, but of course the risk/reward ratio doesn’t change. What are the risks.

RK: There are risks with any kind of investment like this. The primary risk is not being able to meet margin call kind of requirements that we have with our banks. The positions that we create with those banks are all cash collateralised or cash covered under a margin call arrangement so we had to have cash on deposit with the banks to cover the value of those positions that we have with those banks. Our greatest risk is not having sufficient cash internally to meet those margin call requirements with those banks. That sort of market circumstances could cause, or create, a greater call on those cash reserves and it’s our job as manager to ensure that we have sufficient cash on hand at all times to cover the claim on our cash by the banks.

MP: From the point of view of an investor considering getting into this hedge fund, how much of your own skin is in the game? How much have you got invested in your own products.

RK: The manager likes to align our interests with those of shareholders and my investment in the flagship fund is quite significant. I’ve over half a million dollars in our primary investment GoldLink Income Plus. We also have a new investment company called GoldLink Growth Plus which we have just recently listed in August of this year and I’ve also made quite a sizeable investment in that. Most of the directors do have also shareholder interest in both companies and most of the manager representatives also have shareholding in both companies.

MP: Absolute return funds charge higher fees than most investors are used to. What are yours.

RK: Our management fee is on one of the vehicles, on GoldLink Income Plus is 1.5%. On GoldLink Growth Plus it’s 1.75% management fee. We also have a performance fee structure which is 12½ % for GoldLink Income Plus and 15% on GoldLink Growth Plus so it’s tied to performance in those particular instances.

MP: Which for hedge funds is not particularly high.

RK: No, it’s within the cheapest end norm you could say on management fees and 20% performance fee norm on performance fee globally.

MP: But there’s no hurdle rate.

RK: But there’s no hurdle rate. We don’t tend to work on the exact principles that other hedge funds work off. We like to be a little bit self defined in our own sort of way. We’d rather lower the performance fee without necessarily having a hurdle. As an absolute return fund manager our goal is to generate positive profits year in year out. We don’t believe in benchmarking ourselves against an index. That is, it could be an index which is going negative. We prefer to focus on absolute returns and that is generating profits year in and year out.

We’ve been profitable for every year of our operations since we’ve started. That is our primary goal. Just be profitable. And so we align our performance to profitability, not against some sort of arbitrary index or hurdle.

MP: Do you expect at some stage to have a losing year.

RK: Potentially indeed. You can’t discount that possibility. We’ve had a good run but there are challenges which always you have to face as a fund manager. It is our job to analyse continuously the risks and the risks globally and specifically in our markets. We have to identify what those risks are and look to manage those risks accordingly.

MP: Well certain investments are undergoing a bit of a surge in [popularity]. The weight of money chasing things to do. Does it concern you, some of that money, what it’s after?

RK: Not necessarily at this point in time. The pie is getting bigger, when I talk about the pie, the superannuation pie, the mutual fund pie overseas, pension fund pie and they are looking for investment alternatives to compensate when their standard asset classes are underperforming and for a number of years now, excluding the last 12 months the equities markets have really underperformed. Property perhaps has peaked in a number of countries including Australia and people are looking for alternative investment streams to compensate for potential underperformance in those other asset classes. We are coming from a very low base in Australia where alternatives have been only belatedly embraced by the market. Overseas in the North American market it’s not atypical to find institutions investing up to 40% of their total funds into alternatives. In Australia we’re just emerging into this asset class and people are'¦ at the moment are looking at allocating between 5 and 10 percent and that is of a global pool of available monies so I think we’re playing a little bit of catch up here to what are overseas norms.

MP: Do you have a peer group?

RK: Our peer group is really those investments that operate in the alternative investment space. Those investments that are offering low to inverse correlation to the standard asset classes. That is those investments that do well when the goodies are underperforming or property is underperforming, or fixed interest is underperforming. Really we sit within that general alternative investment space that are seeking to outperform those other standard asset classes. Particularly when those other asset classes are being negatively affected or under-performing.

MP: Is there an alternative investment managers’ club that gets together on Friday night down the pub and discusses the job?

RK: There’s the alternative investment managers’ association known as AIMA. This industry is full of acronyms, so AIMA is one of them. There is an Australian chapter to the London based AIMA organization. It’s very active organization within this country and certainly has got a very active club of alternative investment managers.

MP: Is there a limit to how big you can be and play this game.

RK: This market is quite specialised. It is a big market. It is underscored by the central banks’ holdings of gold around the world which is quite significant. We think there’s quite considerable room to play to invest in this market. Currently we’re managing approximately $165 million. We’d like to take that up to around $500 million Australian. Now we’d like to level out around there. For us in this particular funds management or investment strategy it’s not about managing a large amount of money that is in the billions. It’s about managing maybe a couple of hundred million dollars and managing it quite tightly so as not to dilute returns to the shareholder, and that’s something which we’re quite fixated on. We’re not running hard to raise every extra dollar that we can. It’s all about preserving the profitability per dollar under management.

MP: And while you make money whether gold goes up or down, do you have a view on the gold price?

RK: It’s an inevitable question. We think gold is currently trending upwards. There’s a lot of forward momentum built into the price underscored by high inflationary expectations being fuelled by higher energy costs, higher gasoline and petrol prices at the moment which now are feeding into other sectors. Groceries and other perishables. Airline costs and the like. So there definitely is going to be an upward bias to inflationary expectations. Gold has traditionally been recognised as a quasi-inflation hedge both here and overseas. So I think there is a bit of flight to gold by way of inflation hedge. The weakness in the US dollar could re-emerge even though it has been a little bit stronger in recent times as a good proxy against the weaker US dollar. Not forgetting of course that the US still has quite strong fiscal issues upon which it’s got to address being the deficits. So they could re-emerge as a front page issue in times to come and we’ve seen gold perform particularly well during US dollar weakness, so I don’t think those two issues are going to go away in the very near term. Currently gold is very much in play. It’s reached recent 17 year highs and at around $465 per ounce, US per ounce in recent weeks and it could push towards the magical $500 US figure which would be a 20 year high for the gold market. So my medium term view is probably upward momentum, upward trend but going into 2006 we see that it may come undone a little bit given that US interest rates are on the rise and typically gold comes under a lot of pressure when interest rates particularly in the US are at higher levels and as we have a Fed Funds rate which moves beyond 4% potentially in 2006 that could create quite a bit of selling interest in the gold market, thereby capping the gold price, probably in that $500 US vicinity.

ENDS