Update No. 293 – 15/04/17

I committed on Twitter earlier this month to outlining how it came to pass that our net brokerage is a negative number for FY17. I have often said it is our aim to run the most open fund in Australia, so I will outline how we do it.

In simple terms, EGP has spent $2,052.47 on ‘buy’ brokerage for $4,362,627 of purchases FY2017 to date.

We have spent $1,122.70 on ‘sell’ brokerage for $1,646,278 of sales FY2017 to date.

This amounts to 4.7 basis points of brokerage for the buys and 6.8 basis points of brokerage for the sell, excluding GST.

A large part of the reason we keep brokerage costs so low is because we seldom use full-service brokers. Most of our brokerage is through discount brokers.

We do however have excellent relationships with a number of full-service brokers, who occasionally bring us ideas like ‘block-trades’, which if they are attractively priced, make ‘full-service’ costs of 30 basis points a sound investment.

These brokers also bring us capital raising propositions and such purchases are usually free from brokerage for the buyer (though the entity raising capital is usually paying a handsome price…). We have participated in a number of such transactions year to date, which has substantially reduced the brokerage on the ‘buy’ side.

Finally, when an underwritten capital raising that we would like to participate in comes across our desk and we like the look of it, rather than participate in the institutional component of the offer, we on occasion offer the underwriting broker that we will ‘sub-underwrite’ the deal. In this way the underwriter lays off some of their risk and we get to earn a portion of the underwriting fee. So far in FY2017, we have sub-underwritten 3 deals, earning $19,000 for the fund, excluding GST.

Most people would say that running an $11.3m portfolio with only $3,175 of brokerage is pretty frugal. Well in FY2017 so far, EGP Fund No. 1 has actually made $15,825 profit in brokerage in its share dealings.

The remainder of all other costs of running the fund YTD have amounted to $10,798.94. This figure includes rent and utilities, audit/tax return, ASIC costs and bank fees.

So total operating costs for FY2017 to date have been $13,974.11 excluding GST. But after subtracting the $19,000 we have earned for investors sub-underwriting capital raisings, our net operating costs for FY2017 to date negative $5,025.89, our costs this year have been a profit centre!

We like to think that such outcomes are an attraction of having your fund-managers capital invested alongside your own – attention to costs will be sharper than otherwise.

We eliminated two holdings in the early part of April, to prepare capital for adding to an existing position and establishing a new position. We sold all of our position in Clydesdale Bank (CYB.AX), the remainder of our CYB position amounted to just under 2.5% of the invested capital of the fund at the time of sale and our IRR over the entire holding period for our CYB holding was 35.1%. We variously had in excess of 5% of our capital committed to this idea, so the gains have been meaningful for the fund.

The second elimination was Flight Centre (FLT.AX). FLT was a little over 1.5% of the funds invested capital at elimination. Out IRR for the FLT holding has been just a little over 4%, and it has consistently been a fairly small holding. So this idea amounted to too much effort for a very modest return. Our thesis when investing in FLT was that the margin compression of the ever expanding ‘low-cost carrier’ share of the travel market would take a while to work through FLT, whereupon a resumption of the traditional earnings trajectory and operating leverage of FLT would occur. We are less certain now this will occur than we were two years ago.

In both above sales, the capital is simply being redeployed to ideas where the expected IRR is meaningfully higher, but in the meantime the consequence is that our cash levels are back up to 15.8% – Tony Hansen 15/04/2017

^{*1 after a 31 May 2013 dividend of 2.333 cents per share (cps) plus 1.000 cps Franking Credit, a 31 May 2014 Dividend of 7.000 cps plus 3.000 cps Franking Credit and a 31 May 2015 Dividend of 8.6667 cps plus 3.7143 cps Franking Credit and a 31 May 2016 Dividend of 6.0000 cps plus a 2.5714 cps Franking Credit}

^{*2 calculated based on dividends reinvested}