The portfolio was up 1.89% in May, while the benchmark rose 1.09%. The G&W portfolio now trails the benchmark by 2.87% since inception.
There were two significant movements in the portfolio in May.
I bought one new stock, which now accounts for 16.16% of the portfolio. It is the opportunity I briefly alluded to
in my March update. This stock has a market cap of $660,000 at our purchase price, no debt and close to $620,000 cash at bank. It earned about $140,000 in NPAT last FY, which puts it on a P/E of less than five. About half of that was paid out to shareholders, putting the gross yield at 13.79%. While this stock is undoubtedly attractive on a statistical basis, there are some drawbacks. Firstly, while it is clearly undervalued, corporate action (e.g. a takeover) is impossible. It also is very thinly traded. This is great for buyers (like us in May) but means that quick selling is out of the question. Nevertheless, I find it hard to see how I lose money. I suspect the majority — if not all — of this stock's returns will be via dividends, which at about 14% are nothing to laugh at. As an investor far better than me told me today, the important thing in situations like this is to figure out how to reinvest the dividends at a satisfactory rate of return. Due to the small size of the portfolio, we may be able to continue investing in unusual situations like this for some time, but eventually they will become impractical. (This is one of the many reasons why these securities are so attractively priced.)
The other noteworthy event during the month was the conclusion of a risk arbitrage position, which was also alluded to in the March update. The stock in question in was Mantra (ASX:MTR), which was taken over via scheme of arrangement at the end of the month. In hindsight, even though the merger completed successfully, and I made a small profit, the purchase was a mistake. I will try to outline my thinking in the hope of preventing a repeat in the future, which could prove much more costly. There were a few reasons I liked the opportunity: the acquirer was a multi-billion-dollar corporate giant, the major regulatory hurdles had been passed, and the deal was free of any overly stringent conditions. What was particularly attractive was the special scheme dividend, which the scheme documents described as being a maximum of 23.5c per share, which would be deducted from the $3.96 headline figure. I used that 23.5c dividend in my calculations, which looked as follows.
Buy price: $3.94 + brokerage (on my small parcel, the gross cost was $3.96 per share)
Consideration: $3.725 per share in cash
Special Dividend: 0.235 per share (0.34 grossed up)
Gross return: 2.5% (14.24% annualised, assuming deal closed at the end of May)
If you surmised, as I did, that the deal was highly likely to go through, that 14.24% annualised return looked quite attractive, even if the deal took longer than planned as is often the case. Instead, the dividend ended up being reduced to 16 cents, which dropped the gross return to 1.69%, or 9.47% annualised. (We also should be able to record a modest tax loss, as the consideration was less than the purchase price.) This is an unacceptable return considering the level of risk involved. Also, the position of about 5% was far too large. Risk arbitrage has been likened to picking up pennies in front of a steamroller for good reason. While this situation resolved in our favour, I would be ashen faced in the unlikely event it fell through: Mantra was trading about 30% lower than our purchase price in October, before the scheme was announced. For this kind of risk, I should have been demanding much more than 14.24% per annum, which I didn't even end up getting.
