Senvest: invest in a great hedge fund at a big discount?

I know, I know, you are expecting a follow-up post on my Italian REIFs thesis, but a friend pressured me into looking at Senvest in the meantime. So blame him if this isn’t what you wanted to see ;). Anyway, the investment case for Senvest appears to be compelling. The company has a big investment in its own funds and a reported book value/share of CA$221 at the date of the latest quarterly report while the stock is currently trading for CA$166. This already represents a 25% discount, but the picture is probably a lot better because the main fund of the company has performed great in the subsequent five months.

NAV/share of the Senvest Partners fund increased 23.3% between 30 September 2014 and 28 February 2015. We can use this return as a crude measure to approximate the current book value per share of Senvest. Doing this gives us a book value of ~CA$272/share which implies a 40% discount. But it gets even better: those returns are measured in US$ while the company reports in CA$. With the US$ appreciating approximately 12% versus the CA$, we could be looking at a book value of ~CA$305/share and a discount of ~45%. That sounds pretty great for a hedge fund that has generated a >20% return since inception in 1997.

Figuring out if the company is a good deal at that discount should be a relative straightforward exercise. The value of their investments can be approximated by taking the current value, add a premium for estimated future alpha while applying a discount for operating costs and tax inefficiencies. The value of the business itself can be based on the amount of fees they generate. It’s a simple business model to understand, in theory…

Understanding Senvest

Unfortunately, the reported financials of Senvest are one major clusterfuck because they are required to consolidate their funds with the operating company. One of the results of the consolidation is that the management fee that flows from the funds to Senvest disappears since it is now an intra-company transaction. At the same time costs that were payable by outside investors appear on the income statement of Senvest. Economically it is of course not changing the situation: it just makes it harder to understand.

I think that the fees earned and the costs shared with outside investors are now reflected in “change in redemption amount of redeemable units”. But since the value of these units also change based on the returns of the fund it just becomes a gigantic mess. I don’t think it is possible to extract from the current financial statements the effective amount of the management fees that flow from outside investors to Senvest, nor is it possible to calculate what percentage of the incurred costs are paid by outside investors. But perhaps it’s my limited accounting knowledge that is the problem here, so if I have a reader that knows how to figure this out I’m all ears! Because what I want to know is basic: what kind of TER are you paying if you buy assets through Senvest?

Luckily the consolidation of the funds into Senvest is a new development, so we can just look at the income statement of Senvest for the year 2012 to get an idea of the costs of running Senvest. The funds lost money in 2011 and ended near the high watermark at the end of 2012, so it’s a good year to evaluate since it should represent, to some extent, fixed annual costs:

Income statement 2012

You can see the effects of the consolidation in the income statement. Total costs for running the company and the funds were CA$21,7 million and CA$3.3 million of those costs were borne by outside investors while the company also earned $2.7 million in management fees. Unfortunately (for us) those fees don’t all accrue to shareholders since the CEO of Senvest, Richard Mashaal, receives 40% of the annual fee through his ownership of the entity that acts as an advisor to the Senvest Master Fund and Senvest Israel Partners fund. This is however not visible in the above statement since it is accounted for as income attributable to non-controlling interests. So shareholders effectively only got CA$1.6 million in management fees.

If we add this all up we get effective annual expenses of CA$16.8 million of which $CA6.1 million are operating costs for the funds (interest, transaction costs and other expenses) while the remainder are the net costs of the employees running the fund. With an starting equity of CA$285 million and an ending equity of CA$359 million in 2012 that turns out to an total expense ratio of ~5.2%. You need to generate some serious alpha to overcome this hurdle!

And remember: this is in a year where the company didn’t earn, but also didn’t pay a lot of performance bonuses. When we look at 2013 there are almost CA$60 million in costs. If we adjust these costs based on the same split as in 2012 we get the following picture:

Senvest operating costs 2013

The high costs are mainly the result of the fantastic performance of their funds in 2013. The good news is that Senvest also generated CA$18 million in management fees for net yearly operating costs of approximately CA$34.8 million. During 2013 equity increased from CA$359 million to CA$630 million, which gives us an implied TER of 7.0%. A bit higher than in 2012, but it seems that the majority of the bonus payments can be netted out against the 1.5% + 20% fees that are payable by outside capital. Note that these numbers are without accounting for taxes. In 2012 and 2013 taxes accounted for respectively 1.0% and 2.5% of average equity.

Conclusion

Given Senvest’s track record it appears that they are worth their money since they have generated an annualized return of more than 20% since 1997. Unfortunately, the possibility that some manager is capable of generating alpha is not something I want to pay for since the base rate of this being true is extremely low. And while Senvests results sound great their strategy appears to be leveraged long, so risk-adjusted it’s probably less impressive.

When we see Senvest as an investment fund with a TER that varies between 5% and 10% the current discount suddenly looks a lot less attractive. It’s really unfortunate that they don’t have enough outside capital to generate a decent management fee that can offset their operating costs. I love buying assets