.Long term effects of the new performance fees on shareholder returns
At the Albion Venture AGM last month, the Chairman was asked during one of the Q&A sessions:
“Did the Board model the potential impact of the old scheme vs the new scheme over a period of 5 – 10 years? VCT shareholders tend to be long term shareholders and it is the accumulative effects of additional costs year after year which are extremely damaging to long term returns. So did the Board do modelling and quantify under different scenarios to assess the impact of the new scheme vs old scheme?”
In his reply the Chairman told Shareholders :
“Yes, the Board did the maths; it is not a difficult exercise….”
Having now performed my own basic modelling using a bespoke Excel spreadsheet specifically designed for the purpose, I have come to the unavoidable conclusion that either the Chairman was being economical with the truth (again), or he has little or no grasp of the effect of compounding on long term investment returns and he should read up on it before engaging with shareholders in the near future to listen to their concerns.
Using the financial year end NAV (79p/share), the long term average return for the VCT (6.5%) and the March 2019 RPI figure (2.4%) and assuming that the 5p dividend is maintained , it is quite an easy task to look at the effect of both the New and the Old Performance incentive schemes on NAV (and dividend cover) over time, see link to spread sheet used to perform the calculations and table below with the output using the variables above:
https://drive.google.com/file/d/1vMu3ZM ... sp=sharing. NAV (p/share) NAV (p/share)
New performance fee Old performance fee
March 2019 79.0 79.0
March 2024 77.9 79.8
March 2029 76.4 80.8
March 2034 74.4 82.3
Alarmingly with the new performance fee, the NAV takes a hefty fall of 4.6p/share over a 15 year period and this would probably result in a dividend cut at some stage, whilst with the old performance fee arrangement, NAV increases by 3.3p/share. This means that over the 15 year period, the manager pockets an additional £6.7m at shareholder’s expense.
Using all the same the same assumptions, but taking a more pessimistic view on the outlook for the economy (RPI down at 1%), the situation is even more grim for shareholders with NAV falling to 69.4p resulting in a transfer of wealth of around £11m from shareholders to the manager over a 15 year period.
. NAV (p/share) NAV (p/share)
New performance fee Old performance fee
March 2019 79.0 79.0
March 2024 76.7 79.8
March 2029 77.5 80.8
March 2034 69.4 82.3
If RPI is running at 2% and the performance fee is reduced to 15% with an hurdle of RPI plus 2% (which is still relatively generous towards the manager compared to most of the other schemes run by the top 20 VCTs), the outcome for the shareholder is somewhat better, but still highly remunerative for the manager, amounting to an additional £5.1M going to the manager at shareholder’s expense over a 15 year period.
. NAV (p/share) NAV (p/share)
New performance fee Old performance fee
March 2019 79.0 79.0
March 2024 78.4 79.8
March 2029 77.5 80.8
March 2034 76.3 82.3
The spreadsheet is easy to use for any set of variables, I have currently set it up for a constant RPI, a constant annual return, a constant % share going to the manager and a constant dividend, athough these four constants can easily be changed by entering different values in cells G2, G3, G4, G5 respectively. It is also possible to vary three of these parameters each year by just overwriting the values in row E (RPI), row H (Annual return) and row J (Annual dividend) to see the different effects on NAV/share and dividend cover.
I have now tried a number of scenarios using the spreadsheet and the only way shareholders end up being no worse off under the new performance fee is if the VCT performs badly, or RPI races ahead, which are two scenarios which nobody should want.
The Board of directors should have been upfront about these adverse consequences in the documentation that accompanied the announcement of the General meeting (but they chose not to be). Furthermore there should have been worked examples of different scenarios similar to those above which would show the real corrosive effect of the newly introduced performance fee incentive scheme on long term shareholder returns. The Chairman should now reach out to shareholders (preferably through ShareSoc) to listen to their concerns first hand before going back to the manager to renegotiate terms of the newly introduced performance incentive scheme.
In the next few days I will endeavour to write up one further short piece on alternative ways to attract and retain talented Investment managers, which will mean all points raised by the Chairman in support of the punitive structure for the new performance fee will have been addressed and rebutted.
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