Sprott Asset Management’s attempted takeover of Central Fund of Canada
Ned Naylor-Leyland, manager of the Old Mutual Gold & Silver Fund, explains why he’ll be voting against the deal... and urges others to do so.
For over two years Sprott Asset Management (Sprott) has been trying to win control of the management of Central Fund of Canada (CEF) physical gold and silver bullion assets, in an attempt to consolidate the bullion fund industry. There is no doubt in my mind that this is not in the best interests of CEF shareholders. The ‘agreement’ between Sprott and the common shareholders of CEF announced on 04 October does also require the approval of 66.6% of class ‘A’ CEF shareholders. Below are the reasons why, I believe, this latest approach should be rejected.
In the interests of full disclosure, I should declare that the fund I manage holds large positions in both Sprott Physical Gold Trust and Sprott Physical Silver Trust, as well as the Central Fund of Canada.¹ As such, I feel well equipped to comment on the latest move.
In my view, it is plain to see why the proposed transaction would benefit Sprott. The sheer scale of CEF’s bullion assets would make the operations of Sprott larger and more efficient. Indeed, on the conference call announcing the proposed deal, Sprott’s CEO, Peter Grosskopf, said:
‘With this acquisition we are deploying our existing cash balances to secure a reoccurring high margin management fee stream.’
Additionally, the ‘Benefits of the Transaction’ presented to the market on 04 October revealed, what I deem to be, the real reason behind the agreed deal:
‘Legal and consulting fees associated with prior litigation between the two entities will no longer be a drain on the corporation and the litigation will be discontinued.’
We can see from CEF’s filings that the historic annual management fee of 0.31% has swollen markedly since 2015, courtesy of Sprott’s ongoing efforts to force a hostile takeover. The annual reports show that in 2015 annual charges would have been 0.32% but for legal costs. In the event, they increased to 0.38%. In 2016, the fee would have been 0.33% and ended up at 0.35%. Now let’s look at charges for this year. Due to an avalanche of additional litigation, CEF’s charges are likely to break through the 0.4% level for the first time in the fund’s history. Sprott is proposing an annual charge of 0.4% for its new vehicle. High charges indeed, seeing as the average cost to CEF shareholders since 2008, and up until the litigation began in 2015, was just 0.315%.
Charges aside, I have other concerns. The unique no redemption feature of CEF causes it to swing either to a deep discount or a lofty premium, relative to its net asset value, depending on prevailing sentiment towards monetary metals investing in the West. This makes it an altogether different animal compared to redeemable products such as those already offered by Sprott.
Over the course of the life of CEF, the stock has traded as low as a 17% discount to NAV and as high as a 30% premium. Indeed, the fund has traded at a premium to its NAV for almost two thirds of its lifespan. If CEF investors believe, as I do, that we are entering a new bull phase for gold prices (in US dollar terms) then they would be giving up substantial future upside premium if they vote this transaction through.
Those who have studied the bullion banking market in detail also know that banks have huge gold obligations against which they hold little physical bullion inventory. As such, if and when there is a run on gold obligations, banks could look to redeemable bullion vehicles as a way to make good on their bullion obligations. In principle this puts all types of redeemable bullion vehicle at risk of being redeemed were a run on unallocated gold to happen down the line.
If this deal goes through, Sprott management gets what it wants, common shareholders of CEF get a big payday, while the ‘A’ class shareholders give up the 1 cent annual dividend and any future NAV premium participation. Class ‘A’ shareholders would also be facing materially higher management fees should this agreement be completed on. The circular to shareholders was promised by the end of October to give them time to consider the proposals ahead of an end of November vote. We have just been told by CEF that the document will not be posted out until 09 November, giving, at best, just two weeks between receipt and the voting date.
I, for one, will be voting against the proposed deal. I strongly urge other investors to do likewise.