Urbana has been one of the first stocks I wrote about on this blog, and it’s also one of the few investments I have realized a loss on. But after selling my position at the end of last year the fund has gained more than 100%, and a reader asked me a question worth a blog post: “Are you still happy with your decision making process? Should you have had more patience? Should you have re-bought when the company started repurchasing shares again?”
Background
I have a lot of new readers since discussing Urbana for the first time, so to summarize the story: Urbana is basically a closed-end fund with the majority of holdings in a few publicly listed financial companies (mostly exchanges, but more recently also banks). When I first bought Urbana it was trading at a ~45% discount to NAV, and buying back ~10% of the outstanding shares/year. Because closed-end funds incur overhead and management costs they should trade at a discount, but when you can buy back your own shares at a substantial discount you also make a lot of easy money. Because of the buy backs I estimated that a fair discount should be between 15% and 20%. Despite this estimate I sold almost a year later while the fund was still trading at a 45% discount.
What happened since?
Urbana is now trading at a 33% discount and NAV/share is up 70%: combine these two factors and you are looking at a >100% return that I missed. I didn’t have a strong opinion on the value of the assets that Urbana owned a year ago, or what they own today. The big increase in NAV/share is in my opinion mostly a random result, and a big contributor to the good result was their position in NYX that was acquired at a premium this year by ICE.
Shrinking of the discount
I don’t feel bad that I didn’t anticipate the good performance of the fund, but at the same time it does show that my initial thesis was roughly correct. Investor sentiment does change, and when you buy something at a big discount there is a decent probability that you can sell it at a smaller discount at some point in the future. It’s not a surprise that this occurs at the same time as the outperformance versus the market (even when it is just a random good year). Closed-end funds just seem very inefficiently priced: when the underlying assets are hot investors are willing to pay a premium, and when they are out of fashion the fund starts trading at a discount. This doesn’t make a lot of sense since changes in value are already reflected in the market prices of the underlying assets: there shouldn’t be a huge variability in the discount itself.
So why did I sell?
I haven’t really changed my thinking about closed-end fund discounts between two years ago, and today. The reason I sold Urbana was a combination of factors that made me believe that a bigger discount than I originally calculated was warranted.
- Management was investing money in questionable assets: the amount of money invested in this wasn’t big, but when I saw that the fund manager was putting money in leveraged gold ETF’s I thought my assumption of neutral alpha might be too optimistic. I still think this is true: portfolio turnover jumped from 5% in 2011 to 22% in 2012, and the trading expense ratio jumped from 0.08% to 0.63%.
- Management started investing in a private company that had Urbana’s CEO as a major shareholder. I still think that’s super sketchy.
- The company was buying back 10%/year of the non-voting class A shares. With the share count of this class getting lower the percentage of outstanding shares that is bought back each year is shrinking. Instead of 10%/year it’s now closer to 8%/year.
- They use a little bit of leverage, and the interest they pay on their margin loan is relative high. As a small private investor I can borrow on margin a couple hundred basis points cheaper than them.
So when they stopped buying back shares at the end of 2012 that was the proverbial drop that made the cup run over. Every single negative in the list above isn’t huge, but they all add up, and do make Urbana less attractive. I also think that the fact that Urbana resumed the share buybacks doesn’t mean that I was really wrong.
The big question is: what would they have done if NAV/share would have continued to deteriorate? Management had stated that they didn’t want to reduce the size of the fund too much, and the fact that almost no shares were bought back at the end of 2012 when they were trading at all-time lows seems to support that possibility. I think the timing of the repurchases are a further indicator that management isn’t value neutral. They are now buying back shares at full speed while the underlying is up and the discount is smaller.
Conclusion
The above might all sound very negative, but you have to realize that most of those negatives are just minor compared to how big a 45% discount was. But those negatives were enough of a reason to think that I could find a more attractive idea, and I don’t regret my decision to sell just before the big run-up. If I would have had the choice to put either 100% of my money in the S&P 500, or 95% in the S&P 500 and 5% in Urbana I would have gone for the latter, but with many more options available I thought I could find something better.
In hindsight I would have wished I would have been a bit more patience, but I don’t think I made a bad decision. I was just a bit unlucky to miss some positive variance. With value stocks you often buy something cheap, and you just bet that at some indeterminate point in time something will happen that will realize that value. In the case of Urbana that catalyst came early with a great result, but there were many more possible outcomes that were less favorable. Would they have continued buybacks if NAV/share remained low? What would have happened if the underlying assets didn’t outperform this year? What would have happened if the market itself didn’t have a great 2013? The shrinkage of the discount could just as easily have taken 5 or 10 years, and the value of the underlying assets could have gone down as well as up.
Looking at the good results from 2013 is in my opinion simply a form of results oriented thinking. Urbana was a slightly above average investment, but not a great pick. If I made a mistake it was investing in it in the first place.
Disclosure
No positions in any stock mentioned
Great Post. I agree with you 100%. A lot of small things that bugged me about Urbana. They are not shareholder friendly despite the buybacks.
It’s a mixed bag imo, lots of things to dislike, but it’s not all bad.
I agree. People are too often swayed by outcomes and learn the wrong lessons.
I understand these CEFs as options that’ll cost you 10% a year in opportunity cost. If you know beforehand when the discount will close (promoted by dividends or buybacks or whatever), then fine, if you don’t, then there’s no real way to place a value on it. As it happens, the market was saying “6 years before something happens” and I don’t see any basis in URB’s history to suggest that the market was being too pessimistic.
I don’t know about that 10% opportunity cost. The assets that Urbana owns are expected to generate returns, but I guess the opportunity costs also depends on how much alpha you expect to make from your average investment.
It wasn’t just you; I remember many value investors were at the end of their rope with URB-A at the end of 2013 and had blogged about exiting their positions. The frustration was understandable, but as it turned out also indicated a point of capitulation (if hard-nosed deep value investors sell in year-end exasperation at a discount of 50%, who else is left to capitulate?)
I later posted URB-A on VIC, and still most everyone hated it near $1 for the same reasons. I also hated the drag of management fees; to get comfortable with it I had to speak with Tom Caldwell by phone on several occasions and press him about continuing the buybacks, and also talked with someone who has known him through the Canadian securities industry. My impression was that he is an earnest and well-meaning individual who actually does care about doing what he thinks is right for shareholders, but is in other ways par for the course in his industry (like most managers believes his management does create value, and like most is probably wrong in this).
He does deserve some credit for continuing to buy back significant blocks of stock at a deep discount, when he was not forced to do this, and it reduced the amount he earns in fees. Very few to no CEF managers will voluntarily do this. Of course at any point shareholders would benefit very greatly from liquidation, which unfortunately will never happen. But at a 50% discount, it had become dramatically cheaper than almost all CEFS, most of which have far more shareholder-unfriendly management.
I think you are right to consider fees as only partially offset by accretion from discounted buybacks. One other way to look at discounted CEF investing is that you can effectively obtain a form of non-recourse leverage through owning a portfolio of assets worth 2X your purchase price. But the CEF investor still remains dependent on buybacks or a change in sentiment to reap these rewards directly.
I don’t know how much you can really learn from talking to someone and to people that know him. I would be surprised if he didn’t appear earnest and well-meaning: otherwise he would probably have had a hard time raising money for Urbana (and his other businesses) in the first place. That’s why I prefer to focus on what people do instead of what they say.
About the discount in comparison with other CEFs; one thing to realize that because of the dual class share structure it is impossible for an activist investor to get involved and push for liquidation. That’s why most CEF don’t trade at a discount this big.