Stuart Cartledge

Part of the advantage of the Cromwell Phoenix Property Securities Fund (Fund) over other REIT investment options, is that it is managed to maximise after-tax returns. This is the real measure that matters to investors. Unfortunately, the funds management industry doesn’t typically report this way, instead showing investment returns on a pre-tax basis; and it is this nuance that can lead to the under-pricing of franking credits.

While REITs have historically been trust structures, the more common structure among many large capitalisation REITs today is a combined trust and company structure. This is important, because companies pay tax on their earnings before distributing dividends and it is in this context that franking credits become important. Franking credits were introduced in Australia to stop the double taxation of company profits subsequently distributed to investors via dividends. These franking credits, representing company tax already paid, can be used by investors to reduce their tax bill. On average, over the last 10 financial years, the Fund has delivered franking credits that have “topped up” investors’ income by 0.49% per annum. Given the Fund’s positioning in Sunland, discussed below, the top up delivered in the 2023 financial year was 1.56%.

This article takes a closer look at the somewhat dry subject of franking credits and how they can help to maximise your after-tax returns.

The theory

Some of the stocks held in the portfolio are traditional corporates, subject to Australian tax, and are therefore likely to generate franking credits under the Australian dividend imputation scheme. These are valuable to investors and should influence how the portfolio is managed.

The table set out below shows the impact, with each column representing a different investor category. For example, the second column, labelled ‘Accumulation’ shows how a super fund investor in accumulation phase gets $85 of after-tax value from a $70 fully franked dividend. The performance figures for the Fund only capture the $70 of cash dividend. The uplift goes unreported but is clearly valuable.

In practice: Goodman Group versus Charter Hall Group

Goodman Group (ASX:GMG) (Goodman) and Charter Hall Group (ASX:CHC) (Charter Hall) are both Australian listed property securities that derive earnings from a combination of rental income, development and funds management activities. Goodman is focused on industrial property and diversified geographically with operations in the US, Europe and Asia in addition to Australia and New Zealand. Charter Hall is diversified across multiple property sub-sectors, but the business is focused geographically on Australia.

There are of course many other differences between these two securities, but Charter Hall’s domestic focus results in its corporate earnings being subject to Australian tax, and as a result, Charter Hall pays out franking credits. Goodman’s global business, on the other hand, will likely pay at least some tax in foreign jurisdictions, and these tax payments won’t come with franking credits. All else equal, an Australian investor should prefer the domestic business, because their after-tax returns will be higher.Sometimes it gets even better.

The Cromwell Phoenix Property Securities Fund holds a position in property development company Sunland Group (ASX:SDG) (Sunland). Sunland has been a profitable business for many years and has retained some of its profits to grow the business. As a result, it has built up a significant franking credit balance.

Following a strategic review, Sunland has elected to wind up its business and return all capital to shareholders. Phoenix has held a position in Sunland for many years – we like the business and management team and believe the company has been an excellent steward of shareholders’ capital.

A wind-up of the business may seem like a drastic step, but the share market has never really valued Sunland appropriately, with the stock price trading at a material discount to the book value of the company’s assets for most of its listed life, thereby ascribing negative value to the goodwill of the business. Furthermore, a sizeable franking credit balance has also been ignored by investors. For a tax-aware investor like Phoenix, we find this appealing.

At the risk of over-simplifying the transaction, as Sunland goes through the process of completing projects and selling inventory, it will pay out all cash proceeds as a combination of fully franked dividends and a return of capital. Table 2 shows some key metrics immediately prior to the announcement of the Sunland Group Strategic Plan, and the share price reaction to the announcement on 20 October 2020.

Table 2: Key metrics

Despite the strong share price reaction to the announcement, Phoenix lifted its exposure to the stock given the increased certainty of the recognition of value.

Over the subsequent 18 months, Sunland have made significant progress towards the strategic goal and has recognised further profits from the sale or completion of several development projects, such that the eventual outcome is likely to be even better than the original estimates.

For Australian taxpayers on low tax rates, such as super funds or foundations, the value of such a transaction is ‘super-charged’. Pun intended. Portfolio construction needs to consider a myriad of factors. Most of them require estimates of the future. At least with tax, the framework for analysis is reasonably steady, and a tax-aware strategy can deliver with certainty in a somewhat uncertain world.

Stuart Cartledge

The Cromwell Phoenix Global Opportunities Fund assesses potential investments in a bottom-up manner, selecting the best opportunities, rather than following broad thematics.

Despite this, investment opportunities may have similar drivers – or operate in similar industries – from time-to-time. This is currently the case for the Fund’s exposure to hotel properties – these opportunities all exist for different reasons and have unique risk/reward propositions; however, the true value of each is predominantly derived from the ownership of hotels.

Before examining specific examples, it is worth touching on how to think of the value of a hotel.

Like other types of property, one way to think about valuing hotels is to apply a capitalisation rate to the earnings the asset generates. Unlike some types of property (but much more similar than some realise), hotels need to be refurbished frequently to stay up-to-date and attract customers. Any income should be adjusted lower for a normalised capital expenditure amount.

Those who buy and sell hotels also often think of valuing hotels on a “per key” basis – this describes the hotel’s value relative to the number of rooms available. A well-located, extremely high-end hotel may trade for well above $1 million per key, while a motel in the middle of nowhere would likely trade for less than $100,000 per key.

The per key valuation of a hotel can be used to compare hotel valuations to replacement cost, which is the amount required to replace the hotel from the ground up (inclusive of land). This is important because, if hotels are trading for below replacement cost, it is less likely that new hotels will be supplied in that market. Hotels are extremely sensitive to demand and supply, as anyone who has travelled in peak periods can attest to. As an example, a high-end hotel on the Las Vegas Strip is commonly available for AUD$200 per night. Booking even a basic room in that same hotel during the Las Vegas Formula One event would set you back more than AUD$3,500.

Recognition of the value of hotel properties by listed markets is held back by two components. Firstly, financial results have been negatively impacted by COVID restrictions, meaning that those looking solely at the recent income generated by many properties are underestimating the true earning power. Applying a capitalisation rate to this smaller income number is understating the property’s true value. Secondly, unlike some other forms of property, hotels are held on a company’s balance sheet at the lesser of its depreciated cost or net realisable value. If a hotel was built long ago, this may significantly understate its true value and make it difficult to identify for investors screening for discounts to book value.

With this background detail out of the way, let’s look at some examples in which the Fund invests.

In this article, we examine what it means to be an active or passive investor, and compare the two styles that best represent these polar opposites, benchmark unaware and index investing.

Passive versus active investing

Passive investing is the strategy traditionally employed by index funds and Exchange-Traded Funds (ETFs), whereby the manager holds a portfolio that mirrors the index, and no over or underweight strategies are employed. The investment objective of a traditional index fund or an ETF is therefore to track, but not outperform, its chosen index in the most cost effective manner possible.

Passive investing has become increasingly popular in recent years due to low fees and the average active managers’ inability to outperform over the long term. In the United States, index funds now hold nearly half of the listed share market, while the ETF sector in Australia reached a record high $26 billion in funds under management in February 2017.

Exchange Traded Funds (ETFs) are unitised investment funds that replicate an index, with the objective of mirroring the index’s returns. Units in an ETF are traded on the stock market like ordinary securities.

Conversely, active investing is a strategy whereby the manager builds the portfolio by evaluating stocks based on factors such as value, distribution, asset and manager quality. The fund manager can choose to take positions without regard to their size or benchmark weightings, including investing in companies with minor weightings, such as small capitalisation stocks.

The higher fees associated with active investing strategies should be rewarded with investment outperformance.

On a side note, active investing can also work with benchmark aware investing, to a limited extent. A benchmark aware fund manager, while restricted to selecting stocks based on the benchmark weightings, might also engage in strategic active investing by selecting stock weights within defined limits such as 5% either side of the benchmark position.

Performance against a benchmark– what does it mean?

Investors need some way of tracking how their investments are performing, relative to the specific market sector, and in most cases, performance is assessed against the most relevant benchmark.

A benchmark is defined by the Australian Securities Exchange (ASX) as “a collection of assets that provide a broad representation of an asset class,” acting as a barometer for its performance. As an example, many Australian Real Estate Investment Trusts (A-REITs) will benchmark their performance by either the S&P/ASX200 A-REIT index, or the wider S&P/ASX300 A-REIT index.

At 31 July 2017, the S&P/ASX300 A-REIT index comprised of 31 companies covering retail, office, industrial, logistics and specialist sectors. Each company has a specific weighting in the index, depending on market capitalisation (company size as measured by stock price). At 31 July 2017, this index had a market capitalisation of $125.3 billion in total.

An index fund manager will build a portfolio purely based on the composition of the index and the weighting of each individual stock. An index fund manager will therefore take no strategic positions and consequently will be expected to return a performance exactly the same as the relevant benchmark.

The constraints of index investing

The domination of certain indices by large capitalisation stocks should be considered as it can significantly reduce diversification for an index investor.

In the case of the S&P/ASX300 A-REIT index, the top 10 index constituents accounted for 86% of the overall index as of 31 July 2017. The performance of a small number of companies therefore can have a material influence on the index’s overall return, and in an index investment strategy, can expose investors to being heavily weighted to a very small number of stocks.

Furthermore, indexes can be heavily weighted to certain sub- sectors. In the case of the S&P/ ASX300 A-REIT index, the retail sector accounts for more than 50% of the benchmark, and this too can impact on overall benchmark performance.

For example, in the year to 30 June 2017, concerns about the retail sector due to the “Amazon effect” hit large-cap retail A-REITs such as Scentre Group, Vicinity Centres and Westfield Corporation particularly hard, with returns of -13.4%, -17.3% and -21.5% respectively.

The potential sitting outside the index

The S&P/ASX300 A-REIT index also excludes smaller REITs with market caps below $350 million. Some of these have performed well, including Centuria Metropolitan Office (up 25.5% in fiscal 2017) and Australian Unity Office Fund (up 11.4%). In fact, the median performance of the smallest eight A-REITs in the index was a positive 9.9%, although the impact on the total index return was minimal due to the much smaller weighting of these stocks.

In such an environment, benchmark unaware managers have an opportunity to outperform. Without the requirement to maintain benchmark weightings or invest exclusively in benchmark stocks, they can invest in a much wider range of stocks.

A benchmark unaware strategy also allows for the potential to reduce volatility, with the opportunity to diversify across a wider selection of stocks, and no requirement to own a “risky” stock purely because it is part of the index.

For property investors, index and benchmark unaware styles both have advantages and disadvantages, with the benefits of the former including the lower costs, comfort of tracking the index and not being reliant upon an investment manager’s skills. Yet with the performance of the S&P/ASX300 A-REIT index masking wide disparities in stock and sector weights and returns, a benchmark unaware active approach can provide skilful managers with the opportunity to potentially deliver superior returns.

Stuart Cartledge

There is much written about office, industrial, and retail property; however, the proliferation of specialised real estate investment trusts (REITs) is also increasingly becoming a noticeable factor in local and global markets. Historically, these trusts were viewed sceptically, though there is now a growing recognition of the strong fundamentals of many specialised property types.

A specialised property category that has traditionally been lucrative for Phoenix Portfolios is pub properties. Australians love going to the pub, and it is estimated that there are approximately 9,500 licensed venues across the nation, representing a market size of more than $15 billion.

Pubs are an often-misunderstood, niche investment. The properties have often been housed in unique structures with unusual dynamics, but provide interesting investment opportunities for those willing to take the time to understand their intricacies. In many cases, pubs are some of the safest investments, with extremely secure income streams.

Real old school

In the mid-1800s, John and James Toohey (yes, the founders of their eponymous beer) took control of a site – previously a schoolhouse – on the corner of Flinders and Swanston Street in East Melbourne and opened the Princes Bridge Hotel. Irish diggers and cousins Henry Young and Thomas Jackson later took over the pub, and unimaginatively renamed it Young and Jackson. People from all walks of life have been socialising, eating, and drinking in this building for more than 150 years. Despite all the changes to technology, communication, transportation and so much more, the Young and Jackson pub of today would be eminently recognisable to those who patronised it in the 1800s.

A refreshing ALE

The Cromwell Phoenix Property Securities Fund (PSF) previously had a stake in ALE Property Group (previously traded on the ASX under code LEP), which had ownership of the Young and Jackson.

Indeed, LEP owned more than 80 pub properties previously leased to ALH Hotels, which was majority owned by Woolworths (WOW) ¬- now mostly owned by Endeavour Group Limited (EDV) after a spinout transaction completed in June 2021. EDV is the owner of ALH Hotels, along with BWS and Dan Murphy’s, and has a market capitalisation of approximately $11.5 billion.

LEP made history when it was spun off from Fosters Group in 2003. It became Australia’s first pub rental securitisation and the nation’s first listed pub trust. One of the unique characteristics of the LEP portfolio was the presence of an uncapped market rent review for the properties in 2028. Due to the outperformance of the ALH operating business and long-term nature of the leases, the portfolio was rented significantly below market levels. In 2021, LEP suggested under renting was 35.6% ¬- a figure which may have understated the true amount. LEP had also been curating their portfolio of assets, selling those that happen to be over rented at significant premiums to book values.

Due to the nature of the portfolio, Phoenix considered its cash flows to be amongst some of the lowest risk in the sector, with significant upside over the longer term, due to its significant under renting and the goodwill value of the operating businesses.

That proved to be the view of at least one other market participant, with funds managed by Charter Hall Group (CHC), including Charter Hall Long WALE REIT (CLW), announcing a proposal to acquire LEP in September 2021. The proposal included consideration in the form of both cash and CLW securities and represented a 25.2% premium to the prior day’s closing price. The proposal was approved by securityholders and Phoenix successfully exited its investment in LEP.

A Hero in a red cape: Redcape

Redcape Hotel Group (previously traded on the ASX under code RDC) was another pub owner in which PSF invested. Another unique structure, RDC traded at what is known as an OpCo/PropCo, whereby RDC was the owner of both the pub operating entity (OpCo) and the entity which owns the pub property (PropCo).

RDC was externally managed by MA Financial Group and begun life as an unlisted fund, which subsequently listed on the Australian Stock Exchange, with a mandate to grow quickly by acquiring more pubs.

RDC traded at a consistent discount to its director’s net asset value (NAV), frustrating its external manager. To combat this, in August 2021, RDC announced a somewhat complex transaction in which RDC shareholders could chose to redeem their investment for $1.15 per share, or remain invested in an unlisted fund with quarterly liquidity windows, presenting an opportunity to redeem at a pre-set (and reducing) discount to director’s NAV. As an indication, RDC traded at less than $1.00 per share prior to the transaction’s announcement, compared to the director’s NAV of $1.31 per share.

Phoenix Portfolios believed that at the time of the announcement the NAV was conservative and redeeming RDC units with reference to a future NAV represented an attractive investment opportunity. Furthermore, given the operating business and commitment to pay out earnings quarterly, there would be a strong running yield generated by holding the unlisted investment. A position was established.

The actual results surpassed expectations. Phoenix redeemed its investment on 30 June 2022 at a unit price of $1.5277. After becoming an unlisted fund in November 2021, the portfolio also received 6.55 cents in distributions from RDC. The portfolio’s cost base for RDC was approximately $1.12 per unit, meaning the investment returned a total of a just over 42% during its short holding period, representing an internal rate of return (IRR) of 61%. During this period, the S&P/ASX 300 Accumulation Index returned -15.8%. This was truly a fantastic outcome for investors.

How about today?

PSF has two current holdings with pub exposure – the small Queensland-based Eumundi Group Limited (EBG) is a long-term holding, with a strong management proposition, that we remain comfortable with.

The other holding is Hotel Property Investments (HPI), which was a meaningful contributor to performance of PSF in the December quarter. HPI owns 62 pub properties, predominantly leased to Australian Venue Co (AVC), which is owned by private equity firm KKR.

AVC traces its origins to Coles’ past ownership. HPI’s large exposure to Queensland is no mistake. Under Queensland law, to apply for a detached bottle shop license, the licensee must operate a “commercial hotel” (in common language, a pub), within 10 kilometres of the proposed bottle shop. As Coles desired to operate bottle shops in Queensland it also needed to be a pub operator, hence its ownership of AVC. Under a complex transaction, KKR took ownership of AVC in a manner which allowed Coles to continue operating its bottle shops. Under KKR’s ownership, AVC has grown rapidly and produced fantastic financial results.

At the start of the quarter, HPI traded at $2.93 per share, or a 30% discount to its net tangible asset value. HPI has also periodically engaged small scale sales of some properties at premiums to book value. In late November and early December, entities associated with Tony Pitt’s 360 Capital Group purchased a 13.81% stake in HPI at prices as high as $3.67 per share. Those familiar with Tony Pitt’s history know that corporate activity in some way is likely to follow. HPI was the second-best performing security in the REIT index over the quarter (only behind URW) rising 24.6%, closing at $3.56 per share. How any potential corporate activity will play out remains to be seen.

Finding a Niche

For many, not much time is devoted to specialised, niche investments. Phoenix, however, often finds that some of its best ideas are found by looking at smaller, more complicated opportunities.

If others are unwilling to look into these unique situations, the reward can often be better for those committed to put the time and effort in to find potentially misunderstood opportunities.

Clearly over time, the pub sector has represented one such opportunity and in recent times has provided some very good outcomes for investors. This is representative of only a part of the unique opportunities that are looked at. With more uncertainty than ever in “core” property asset classes, being willing to look far and wide will hopefully be a continued advantage for those invested in this portfolio.

The Cromwell Phoenix Global Opportunities Fund (GOF / Fund) searches for investments with unique qualities that are hard to discover, yet simple to value. Spinoffs provide a fertile hunting ground for these types of situations and Phoenix Portfolios uncovered one in Retail Value Inc (RVI).

A spinoff occurs when a larger business takes a subsidiary, or part(s) of its existing business, separates it into a new, independent company and in most cases distributes shares in the newly separated entity to existing shareholders, whether they like it or not.

Thankfully for us, many existing shareholders do not like it, as the spun company is commonly a lot smaller and/or ‘non-core’ to the broader business. At times this can create strong selling pressure and a wonderful opportunity to purchase the spun off security at a large discount. RVI is an example of an investment that Phoenix naturally gravitates to.

In July 2018, RVI spun out from long-time US-listed shopping centre owner, Developers Diversified Realty (DDR) (more seasoned investors may have some painful memories and financial scars from the formerly Australian-listed Macquarie DDR Trust).

At inception RVI was to own 50 shopping centres, comprised of 38 in the continental United States and 12 in Puerto Rico. RVI was to be externally managed by DDR and had an explicit mandate of selling those assets over 36 months and distributing the proceeds to shareholders.

The assets placed into RVI were described as ‘stable but lower growth’ in the registration document associated with the spinoff. Furthermore, the Puerto Rican assets were said to ‘present uncertain future cash flows because of macroeconomic factors’.

Translating this from ‘business speak’ to plain English, DDR was handpicking its 50 worst assets and selling them because it no longer wanted them.

Readers may be wondering who in their right mind would want handpicked ‘bad’ shopping centre assets. This would be an astute observation and it seems DDR shareholders didn’t want that exposure either. Six months after initially trading at more than $36 per share, RVI’s share price was approximately $25.50 per share (dropping ~30%).

Despite the poor share price performance, RVI was achieving solid asset sale prices, significantly ahead of what was implied by the share price and appeared to be executing on their stated strategy admirably. While this looked like an attractive opportunity, this occurred approximately 12 months before the initiation of the GOF. In that 12-month period, RVI continued to deliver on its stated goal of selling assets in a methodical manner, achieving robust sales prices.

Investors started to believe that despite the flaws, the company may present a compelling investment opportunity. As such, the stock price rallied to approximately $39 per share. By the inception date of the Fund, it no longer presented a compelling investment opportunity and as such it was not held. Despite this, it was not forgotten.

Phoenix continued to track RVI’s progress as it continued to sell properties. The period beginning March 2020 presented a tumultuous time, with uncertainty around the ability to collect rent and sell assets as COVID-19 and associated restrictions spread around the world. A restoration of relative normality and more conducive financial markets allowed asset sales to restart in 2021. To July 2021, the vast majority of the assets sold were located in the Continental US. The initial 38 mainland assets were whittled down to only eight, whilst nine of the initial 12 Puerto Rican assets remained.

The Fund aims to invest in areas within the team’s circle of competence. Mainland US retail assets very clearly fit into this, however with the majority of assets in Puerto Rico and limited knowledge of that market, the variance of possible outcomes was too wide to accurately assess.

Who would even bid on a large-scale portfolio of Puerto Rican shopping centres?

The answer was Kildare Partners, a real estate private equity fund run by Ellis Short (some may remember Short as the former owner of English football team Sunderland AFC, also a key character in Netflix documentary Sunderland ‘Til I Die). The $550 million headline price was a very solid outcome, however, there was set to be more than a month between the announcement and cash payment. With such a substantial transaction in a developing jurisdiction, the risk of not closing on the deal seemed high.

In August, it was announced the full cash proceeds had been received. The stock price was unmoved on the announcement and RVI was being valued at a discount to Phoenix’s assessment of the value of what was left. Eight US shopping centres and a big ‘pile’ of cash. As such, we finally initiated a position in RVI.

Investors didn’t have to wait long for further activity. In October 2021, the company announced the sale of five further assets. Phoenix first paid $24.30 per share to acquire a stake in RVI. Two months later, RVI announced a $22.04 special dividend to shareholders, meaning more than 90% of our initial investment was to be returned, along with a holding in the remaining three assets and a smaller but still meaningful ‘pile’ of cash. After the dividend was paid, what was left of RVI traded at a value that was once again attractive to Phoenix and, as such, more RVI shares were purchased at a price of $6.00. Again, it was a short wait for further positive outcomes, with two of the remaining three assets sold and a further $3.27 dividend announced in December 2021.

In March 2022, RVI announced the sale of the final asset and a plan to delist the company from the New York Stock Exchange. With this sale, the only meaningful asset of RVI was (you guessed it) a pile of cash. This amounted to approximately $3.90 of cash (and receivables) per share.

Table 1: RVI share purchases

The last day of trading for RVI stock was to be 6 April 2022. Some investors cannot own delisted securities and are therefore required to sell before delisting occurs. Ready for this, the Fund amassed some cash to get ready for a potential attractive opportunity. The market was co-operative, offering RVI stock for $3.00 per share. With such an incredible risk / reward trade off, Phoenix made RVI a larger position in the Fund.

Six days later a $2.13 dividend was announced, returning more the 70% of the money invested prior to delisting. In June, a further $1.16 dividend was announced. This means that only three months after paying $3.00, RVI will have returned $3.29 to shareholders, with future additional distributions of the remaining $0.61 per share of cash (less wind-up costs) highly likely.

The Fund made three separate purchases of RVI shares. The likely financial outcome of each purchase is outlined in the table 1. From the table above it can be seen that the most attractive opportunity (and largest position taken by Phoenix), occurred when RVI had only cash left on its balance sheet. Due to timing and US GAAP accounting quirks, investors had to be following the RVI situation to discover this opportunity.

When describing the strategy of the Fund, we often discuss the metaphor of buying a dollar of assets for 50 cents, with the goal of getting one dollar (or more) back at an uncertain future date. In this case, a dollar of cash was literally purchased for less than 75 cents, with the very high expectation of receiving a dollar back within six months. RVI has resulted in a strong outcome for investors, and we continue to hunt for more opportunities like it.

Stuart Cartledge

The Cromwell Phoenix Global Opportunities Fund (GOF / Fund) searches for investments that are distinctly cheap and simple to value, yet hard to discover.

Owing to the unique nature of its economy, one such example can be found in South Korea (Korea). While not an individual stock, Korean preferred securities represent a class of stocks which appear to be one of the most attractive, underfollowed and inefficiently valued opportunities globally.

To many Australians, Korea may be famous for its barbeque and kimchi; however, it is also home to some of the world’s largest and most advanced companies. Korea is Asia’s fourth largest economy and is the 12th largest worldwide. Despite this, its share market is mathematically one of the cheapest in the world, with a price to earnings (P/E) ratio of only marginally above nine. This is despite the market being largely constituted of world-leading information technology companies.

Part of the explanation for the cheap valuations is the shareholding structure of many Korean companies. In Korea, many prominent companies – known as chaebol, or conglomerates – are controlled by an individual, powerful family. These chaebol have not always acted in the best interests of minority shareholders and, from time to time, have been embroiled in corrupt behaviour, or have abused close ties to the government. In recent times, chaebol have been incredibly politically unpopular in Korea, which led to comprehensive industry reform. Former president, Park Guen-hye, was recently impeached amid public pressure, in part due to her relationships with chaebol.

Several decades ago, the Korean government pressured chaebol to raise capital to de-lever their capital structure and protect Korean jobs; and, therefore, reduce any civil unrest. The problem for the powerful families was that a standard equity raise would dilute their company ownership and reduce their control. As a result, the owners created a new class of shares – preferred shares – which, unlike other preferred securities that are more fixed income-like in nature, have the exact same economic rights as regular equity, but do not have any voting rights. These shares were issued at slight discounts to regular securities and were mostly purchased by Korean retail shareholders.

Over time, the discount on the preferred securities has widened from small amounts to 30%-70% in many cases. Considering that many Korean equities trade at low valuations, the discounts provided on preferred securities are particularly attractive. Many institutions cannot effectively invest in Korean preferred securities due to their small free float and relative illiquidity.

Let’s take LG Electronics as an example. Yes, that’s the LG Electronics you know for making OLED TVs – previously marketed passionately in Australia by cricketer David Warner. LG is a globally recognised brand, which sells consumer electronics, home appliances, and home entertainment products. Based on broker estimates, LG’s ordinary share price implies a price to earnings ratio of somewhere between 5.5x and 7x – not a hefty price to pay for such a company. The company also has preferred shares on issue. As at 30 September 2022, LG preferred shares traded at a 53% discount to the ordinary shares. As a reminder, the only difference is the voting rights – the economics of the share classes are identical. Assuming LG’s ordinary shares trade at a P/E ratio of 7x (the conservative side of broker estimates), the preferred shares trade at an eye watering 3.3x P/E ratio. Unless you believe TVs (and other home appliances) are going the way of the dodo bird, this clearly presents a highly attractive investment opportunity.

Phoenix Portfolios chooses to access discounts like the one mentioned above for the Cromwell Phoenix Global Opportunities Fund through a basket of Korean preferred securities. Investing directly in Korean shares as a foreigner is a complex process, with challenges beyond the scope of this article. The Weiss Korea Opportunity Fund (AIM:WKOF) is listed in the United Kingdom, with an investment strategy of investing primarily in Korean preference shares trading at a discount to common shares of the same issuer. The fund has best-in-class corporate governance and a well-respected manager. The basket of preferred stocks owned by WKOF trade at an average discount of 53% to their common shares, and a trailing P/E ratio of 4.8x as of September 2022. Given all of the above, Phoenix has chosen to gain its exposure to Korean preferred securities through an investment in WKOF, although this may change in the future. WKOF is one of the largest holdings in the fund.

Since inception, WKOF has been a solid contributor to the Cromwell Phoenix Global Opportunities Fund’s returns. At current pricing, Korean preferred securities appear to be one of the most attractive, underfollowed, and inefficiently valued investment opportunities globally. While this alone does not guarantee success, we believe investing in these types of mispriced opportunities will assist in achieving strong returns over the long term.

Since inception, WKOF has been a solid contributor to the Cromwell Phoenix Global Opportunities Fund’s returns. At current pricing, Korean preferred securities appear to be one of the most attractive, underfollowed, and inefficiently valued investment opportunities globally. While this alone does not guarantee success, we believe investing in these types of mispriced opportunities will assist in achieving strong returns over the long term.