I have to say I think we cynical commentator types should stop endlessly pointing to Woodford as an example of what can go wrong with ‘mission/strategy creep’ by an experienced fund manager and maybe focus instead on JZ Capital Partners as an exemplar of the worst case scenario.

For the record I used to think JZ looked a possible value play although there were clearly some ‘challenges’. My positive argument (which still stands) was that the manager seems to have done a fairly good job over the long term in managing micro-cap private equity funds. I suspect some of the ‘challenges’ would have remained if the fund had stuck to its knitting but that was not to be.

Many years ago, I remember meeting one of the American based principals of the firm (and major shareholder in the fund) as he excitedly explained to me the newest project which was property development (residential) in Brooklyn and Florida. As you’d expect the narrative sounded compelling all those years ago, but I remember thinking at the time that this was a tad ambitious for a small cap PE fund. Put bluntly, isn’t that what a real estate investment trust is supposed to do, not a private equity fund? Obviously one can draw parallels with Woodford’s migration from classic equity income to much riskier private equity. That too was a big leap. But in truth, before it all went wrong, there was some evidence that many of Woodfords private business investments were actually half decent. We all forget that Woodford did well with university spin out businesses for a long period of time and that limited success probably encouraged him to become even more aggressive in building up this side of the business.

In the case of JZ I’m afraid the record is far more black and white. There never was any substantive evidence that the big move into residential property development was a good idea. And over the last week we’ve had yet more confirmation that this was in fact the case. According to a Numis report on the final results from this week, we’ve seen a suspension of monthly NAV numbers until “circumstances allow the company to make informed judgements as to value”. The call between the company, investors and analysts has also been cancelled.

The headlines might suggest why!

For the financial year to 29 February, Numis reports that “the NAV was down 38.8% mainly driven by the real estate portfolio, detracting 42.5%, as well as the European Micro-cap portfolio (-2.5%) and finance costs (-2.4%). These were partially offset by gains in the US Micro-cap portfolio, which added 5.9%, and the reversal of the incentive fee accrual (+4.5%).”

The problem seems to be putting a value on those property developments, with independent valuers brought in. They have now “written down the real estate portfolio, with Fulton Mall ($53.2m at Feb-19) and Design District ($98.5m) being written down to zero”, reports Numis. “The Board note several factors including the general decline of retail, and in New York regulations adversely affecting residential properties, leading to weakness in the Brooklyn and South Florida real estate markets. In addition, there has been either an inability or delay in executing strategic investment plans. High loan-to-value ratios at the property level have also exacerbated the effect of falling appraisals on the fund’s equity investments.”

Yikes! Let’s just step back from this. I have never seen any evidence that this strategy switch into property was backed by a stream of historical transactions which prove the manager knew what they were doing. But the fund still invested a colossal chunk of investors’ money – much of it to be fair from the principals in the business – into a radically different investment class. These projects were not doing terrifically well BEFORE Covid came along but prospects look pretty god damned bleak now. For a residential investment to be written back to zero suggests a rather monumental strategic error. Investors will now be worrying about impending loan repayments with a $150m loan due 12 June 2021, Convertible Unsecured Loan Stock of £38.9m due 30 July 2021 and ZDPs of £57.6m due 1 October 2022.

Which brings me to a possible, tiny, opportunity, although one needs to caveat that positive sounding word with a million and one warnings.

Digging around on the ZDPs, we can see that these have a ticker of JZCZ and were trading at around 440p before things really started to go wrong but are now at around 256p. The final capital repayment is £483.70 per zero when they are redeemed on the 1st October 2022 i.e about 30 months away. Before that redemption date we have the $150m loan with Guggenheim to be repaid plus the £38.9m of CULS, which pay a yield of 6%. These are trading at £11 a share.

So we have roughly $120m of subordinated sterling debts plus $150m dollar debt sitting against current Nav of $475m. So, on paper it looks like that the CULS and ZDPs might be well covered. If that is the case, it might be worth keeping a beady eye on the Zero’s. The market is saying the zeros deeply distressed but there seems, on first inspection, to be a decent slug of equity to eat through, around $200m. There also seems to be enough cash for the time being. Numis reports $52m, so there’s obviously no near-term liquidity issue. I suppose we could see some aggressive renegotiation on the zero’s by the manager but if the zero investors hold the line – “pick on Guggenheim and the CULs first!” – there might be some value in this car crash of a fund via the Zeros.

PRS REIT – a study in contrasts

If one is looking for a complete contrast maybe one could start with the PRS REIT? This is also involved in residential property development like JZ but property of a very different kind. Its focus is on affordable housing and co-ownership schemes in the UK. The managers have extensive experience in this space and the fund looks like a decent long-term value and income play, especially as the large overhang of institutional shareholdings (Invesco I think) is cleared out.

Currently the shares trade at 74p a share versus NAV of 96.7p. That’s a chunky discount but there has also been uncertainty about the regular dividend which as originally set at 5p a share (implying a 5% yield) but was put on hold while the fund and the manager grappled with the impact of Covid. The good news from the trading update this week is that construction has restarted and that c.450 new homes are scheduled for delivery by the end of August. According to Numis that would increase the company’s portfolio to over 2,400 completed homes with an estimated aggregated rental value of £22.2m. Contracted homes currently stand at c.2,900 units.

The other good bit of recent news is that rent collection remains robust with “97% collection rate in May and rental rates remaining unchanged compared to pre-crisis levels. Rental demand also remains high with over 500 reservations awaiting a move-in date, which will add c.£4.6m of annual rent once occupancy has started”.

The fund has also resolved the uncertainty around the dividend and is setting it back at 1p per quarter, and 4p per annum for the year to 30 June 2020 (previously 5.0p), and will target a minimum total dividend of 4.0p for the year to June 2021.

So, by my calculations you get a 23.5% discount to NAV, in social infrastructure assets and a net yield of 5.4%. I think there’s a decent chance we could see the NAV discount tighten to 10% or there about.

Overall, this is looking like a strong buy.

Yep, a Covid ETF

I suppose it was inevitable that the thematic investing brigade, especially in the ETF space, was going to bring out a product that was a play on the post pandemic world. My colleague David Tuckwell who writes for ETF Stream (and Ultumus) reports that we have a winner in the race to be first.

“ETF Managers Group has come in first in the race to roll out a coronavirus ETF, with the ETFMG Treatments Testing and Advancements ETF (GERM) commencing trading this week.

The invests mostly in healthcare biotech companies. It aims to invest in those that develop vaccines, and in those that produce tests for vaccines. Companies are identified based on revenue purity and stages of drug development.

Like a lot of thematic funds, the fund uses funky wedding-cake style weighting system. The weighting system is designed to give medium-sized companies a bigger footprint. It allows companies with market caps under $15 billion to take up to 6% of the index.

Large caps, i.e. those with market caps $15B-plus, get equally weighted with their collective weights not allowed to take more than 10% of the index.

The fund charges of 0.68%.”

I am not too sure about this idea though. First off, my suspicion/worry is that a vaccine is not imminent. Second the pressure to make said vaccine a ‘public good’, distributed at near to marginal cost, will be immense. Lastly my own hunch is that like AIDs we’ll see the emergence of a cocktail of treatments which massively cut fatality rates, making this a manageable disease. That suggests focusing more on ‘traditional ‘pharma approaches, but that trial and error approach will take years and many of the best treatments might be out of patent.