iCapital: "Ostrich policy" will not solve the issues (4)

City of London has sent the following letter to the Board of Directors of iCapital:


Clients of City of London Investment Management Limited (CLIM) own 21,970,900 ICAP shares (15.7%). There has been no action in response to any of the points that were raised in our letter to you dated 26^th August 2015, which set out our concerns regarding ICAP's poor performance and persistently wide discount to NAV.  CLIM therefore confirms that it intends to continue voting against the re-election of incumbent directors. Accordingly, CLIM intends to vote against the re-election of Madam Leong So Seh at ICAP's 12^th AGM on Saturday, 24^th September 2016.

·     Performance

We reiterate our call for performance comparisons in shareholder communications to be made on a total return basis, which is universally accepted in the investment industry as best practice.

The total return in the five years to end May 2016 for the FTSE Bursa Malaysia Index has been 23.1% cumulative (equivalent to 4.2% pa). In comparison ICAP's NAV return has been 13.0% cumulative (2.5% pa). The share price return over this period has been even worse due to discount widening, at 6.4% cumulative (1.3% pa). These performance figures have been sourced from Bloomberg.

The Chairman stated, in his letter to shareholders, dated 19^th July 2016, that ICAP has 'performed beyond expectations'.  We wish to make clear that ICAP's performance over the past five years has fallen significantly short of our own expectations.

·     Cash Management

We note the continued extraordinarily high cash level, which has persisted at over 50% for 3 years and on which shareholders have been paying fees for fund management and investment research services. Cash at each calendar year end since ICAP was launched (31 December 2005 to 31 December 2015) has averaged 39%. ICAP is clearly operating with surplus cash which, in our opinion should be returned to shareholders.

·     Expense Ratio

ICAP's expense ratio in 2016 was 1.9% (2015: 1.9%) which compares unfavourably with other country specific closed-end funds. The most significant item is the aggregate 1.5% incurred for fund management and investment research. CLIM urges the Board to negotiate competitive fees in order to reduce the expense ratio to an acceptable level.

·     Discount Control

ICAP's prospectus dated 26 September 2005 explained clearly that the return for closed-end fund investors is a product of NAV performance and the discount movement. The Chairman's letter to Shareholders in the 2016 Annual Report refers to a 4% rise in ICAP's NAV for the 12 months ended 31 May 2016. However it does not mention that the share price actually declined over this period, because the discount widened. The discount averaged 22% in 2016 versus 20% in 2015 (source: Bloomberg). Neither the level nor the trend is acceptable and CLIM is disappointed that the Board has again failed to take any action to address this problem.

CLIM notes from the 2016 Annual Report the Board's deliberations on 27^th July 2015 regarding share buy-backs and the accompanying statement that the "Fund's NAV could deteriorate if it uses its available fund to purchase own shares". Repurchasing shares at a discount to NAV will actually increase the NAV per share and in CLIM's opinion this would be a sensible use of ICAP's cash, particularly in view of the Manager's apparent shortage of investment ideas.

ICAP's prospectus included a section (6.7, page 64) on managing discounts, noting that the options available include 'share repurchase, open-ending, takeover, liquidation'. CLIM urges the Board to consider all these options and to formulate a strategy to reduce the discount from its present unacceptable level.

MSWG announced it will raise certain issues at iCapital's AGM, for instance regarding the "other expenses" and the impairment loss. I hope they also support the above issues as described by City of London.