Update No. 298 – 30/06/17

EGP Capital

There is a lot of information for our investor group to absorb at this point of the year.

The most important thing that all current investors and those that will join us once the move to a Unit Trust is complete should read is the FY2017 Annual Letter (.PDF). It contains a review of the just completed financial year and a more in-depth overview than our regular monthly updates.

Becoming a Unit Trust has necessitated a return to using the S&P/ASX 200 TOTAL RETURN INDEX over the S&P/ASX 200 FRANKING CREDIT ADJUSTED ANNUAL TOTAL RETURN INDEX (TAX-EXEMPT) that we have used since Standard and Poors created it.

The reason is that our Trustee & Responsible Entity (Fundhost Limited) has said they are unable to add the franking credits to our Unit Price to create a ‘like-for-like’ pre-tax comparison. If we can’t include franking in our performance, then it is unreasonable to include them in the benchmark we follow.

I thought I’d devote this blog to explaining the difference it will make to EGP investors. For those that want the ‘short-answer’, the answer of ‘not much’ will save you from what follows…

Set out below is a table showing the difference between the Franking Credit Adjusted Index (FC) and the Total Return Index (TR) after day one of the past six financial years:

Date FC TR Differential
1/07/2011 1.07% -0.36% 1.43%
2/07/2012 2.60% 0.94% 1.66%
1/07/2013 -0.38% -1.92% 1.54%
1/07/2014 1.11% -0.37% 1.48%
1/07/2015 2.62% 1.04% 1.58%
1/07/2016 1.84% 0.25% 1.58%

 

The rest of the year, these two indexes track each other in perfect unison. You can see the contribution of Franking Credits to returns in the ASX200 is remarkably consistent and measures around 1.55% annually.

Next I’ll set out an Internal Rate of Return calculation for EGP’s returns since inception both including Franking Credits:

EGP (Inc-Franking)
 $(1.000000) 1/04/2011
 $0.033330 31/05/2013
 $0.100000 31/05/2014
 $0.123810 31/05/2015
 $0.085714 31/05/2016
 $0.100000 31/05/2017
 $1.954400 30/06/2017
16.12% IRR Calc

 

And excluding Franking Credits:

EGP (Exc-Franking)
 $(1.000000) 1/04/2011
 $0.023330 31/05/2013
 $0.070000 31/05/2014
 $0.086667 31/05/2015
 $0.060000 31/05/2016
 $0.070000 31/05/2017
 $1.954400 30/06/2017
14.71% IRR Calc

 

The first thing keen eyed observers will notice is that our Franked IRR is slightly higher (0.05%) than the annualised return we report in the table below. This is due to the ‘time-value-of-money’ calculation difference of measuring the distribution at 31 May each year as in the above IRR tables, versus adding it back on to the 30 June price (which is how we’ve handled it to date as reflected in the below table and all reporting).

The second thing you will hopefully notice is that the returns excluding franking credits is remarkably similar to the index. EGP has generated 1.41% annually of Franking Credits for its investors.

So in simple terms, if our returns profile (i.e. the proportion of our returns that come from franked dividends and capital gains) remains similar to the past 6 years, then the difference to our investors should be negligible.

Given our outperformance excluding franking was 0.14% higher on average over the past 6 or so years; it would effectively mean a performance fee about 2 to 3 basis points higher on average.

If one wants to argue that franking credits are worthless, one should only look as far as the scheme announced Monday June 26th between Seymour White Limited (SWL.ASX) and VINCI (DG.PA).

If Franking Credits were truly worthless to Australian shareholders, the price of SWL should not have traded higher than the $1.285 offer price. The fact that the bidding opened and held at $1.35, fully 6.5cps above the cash offer indicates this is not the case.

To give you an idea of whether EGP will still value Franked returns above ordinary returns, we bid heavily at $1.275 per share (unsuccessfully) at the open. That price had an IRR of 1.83% based on the cash price (so a level of return which will do the reported performance no favours at all), but a 40.44% IRR based on the maximum fully-franked dividend of 44.5cps and timely closure in November.

The $1.35 price actually still had an IRR of more than 20% assuming the fully franked 44.5cps dividend and timely closure. But when using the ASX200TR index, I would be foolish to buy SWL.ASX at that price as I would be creating a 6.5cps loss I would need to report against my benchmark, whilst the more than 19cps of franking credits would not be counted. So despite the rational thing to do (assuming you are confident the deal closes) financially being to buy the shares at $1.35, we sat out. I will work hard to maximise the pre-tax return I generate, but will not punish our reported performance – Tony Hansen 30/06/2017

Apr 1st2011 Jun 30th 2016 Current Price Since July 1st 2016 Since Inception Annualised
EGP Fund No. 1 1.00000 1.7013 1.9544*1 20.75%*1 153.80%*2 16.07%*2
Benchmark 37333.23 52006.69 60271.82 15.89% 61.44% 7.96%

*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, a 31 May 2015 Dividend of 8.6667 cps plus 3.7143 cps Franking Credit, a 31 May 2016 Dividend of 6.0000 cps plus a 2.5714 cps Franking Credit and a 31 May 2017 Dividend of 7.000 cps plus 3.000 cps Franking Credit

*2 calculated based on dividends reinvested

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