January 2010
As a conversation stopper telling someone you are a tracker fund manager is about as good as saying you are a traffic warden. It makes a good excuse to edge closer to the canapés and drinks. But not all tracker funds are the same and the portfolio of a fundamental tracker fund, such as The Munro Fund, has significant differences from a conventional market capitalisation weighted fund. It is this difference that creates the potential for a better return than conventional trackers.
Examples make explanations easier. Anglo American has a market weight of 2.37% yet only 0.36% of the Munro Fund is invested in it. Why the discrepancy? In 2009 Anglo American surprised investors by suspending dividend payments and said they would be reinstated when market conditions allowed. It did not pay an interim dividend and few analysts are expecting a final dividend to be declared when it reports results for 2009 in February 2010. Dividends are a key part of the covenant between investors and managers. Investors supply capital to the managers in order for them to generate cash, not just profit. That cash can be then be used to grow the business but there is usually a clear understanding, especially in mature businesses, that some of that cash will be returned to investors as a reward for the use of that capital and as a gesture of good faith. Banks have dramatically proved in the last few years that the inherent tension between principals and agents can be stretched too far.
Managers have day to day control of the cash and it is often easier to find new and exciting projects to spend the cash than return it to the providers of capital. In the case of Anglo American its immediate downfall was the multi-billion dollar iron ore project in Brazil. But that was just one of many problems. The sharp contraction in the world economy at the end of 2008 sent commodity, and especially diamond prices plunging. Anglo American has a 45% stake in De Beers which needed emergency financing after closing all its diamond mines due to the financial crash. Even though diamond prices have recovered a little volumes are still low and how De Beers will refinance itself is unclear. Will it need a rights issue?
Then there is the 80% stake in Anglo Platinum. It is has $3b in debt and is struggling to find cash flow for capital expenditure. Will it too need a rights issue? All these, and other, pressures on Anglo American convince analysts that a meaningful dividend is unlikely for some time. Instead it has to decide how to ration the pot it has and consider whether to ask for more. The stock market has placed this company in the select group of corporations that are expected to pay out over a £1billion pounds in dividends next year. Our data indicates that even a quarter of that would be overly generous which is why the fund has a modest exposure. The question is why do other trackers hold so much?