Global Report
Why Offshore Investment Companies Offer Such Attractive Value Now.
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Local Report
South Africa’s Electricity Sector Transformation.
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Global Report: Why Offshore Investment Companies Offer Such Attractive Value Now
By Nick Downing
How would you like to own shares in Nvidia but at a 10% discount to its current trading price? Many would agree that such an offer is certainly attractive, but not feasible to obtain. However, such a unique value proposition is achievable through the use of offshore investment company holdings.
It is for good reason that investment companies, which form the basis of Overberg Asset Management’s (OAM) global private share portfolios, are known as the City of London’s “best kept secret.” They have been around since Victorian times, yet few know about them apart from financial professionals and institutional investors, since they do not come with fee-based distribution incentives like unit trusts or other collective investment schemes. Here we outline their top three distinctive benefits.
1. A closed-end structure: Investment companies only issue a limited number of shares. This means the share price of the investment company may diverge from its net asset value (NAV), but this creates an added opportunity for investors as prize assets can often be bought at a discount to NAV and sold at a premium to NAV. The NAV discount cycle tends to move in tandem with business cycles. Discounts tend to widen ahead of bear markets as occurred in 2022 and most of 2023, when interest rates surged at the fastest pace since the 1970s. The discounts have since narrowed in line with falling inflation, declining interest rates, a recovering global economy and a burgeoning productivity boom driven by Artificial Intelligence.
The aggregate NAV discount of the 400 or so London Stock Exchange listed investment companies is currently 9%, compared with a peak of 17% in October 2022 but still far from its long-term average with considerable potential to narrow further. Before Covid struck the discount was just 1.3%. The outlook for investment companies is the most attractive that is has been for years.
Hedge funds and institutional investors are circling. They recognise the value. Hipgnosis Songs Fund, which earns its revenue from music royalties, was trading at an eye watering 50% discount to NAV before receiving an all-cash takeover offer from Blackstone at an 18% premium to the adjusted operative NAV. The share price increased accordingly, gaining by 92% over two months, adding to the returns of OAM’s global private share portfolios.
Scottish Mortgage, well known for its early-stage investments in Amazon and Tesla and more recently in Nvidia, has attracted the attentions of activist hedge fund manager Elliott Management, which built up a 5% stake in the company. The size of Elliott’s investment pressured Scottish Mortgage into narrowing its NAV discount. It announced a £1 billion share buyback programme, the largest ever used by an investment company.
Another hedge fund, Saba Capital, has built up sizeable positions in Baillie Gifford’s US Growth Trust, JPMorgan’s European Discovery Trust and BlackRock Smaller Companies Trust. The pressure to narrow NAV discounts resulted in record investment company share buybacks of £3.6 billion in 2023. When NAV discounts get too wide, they tend to self-correct in line with market cycles, but investors can also take comfort from Discount Control Mechanisms used by investment companies. As well as share buybacks, mergers, buyouts, and managed wind-downs, all serve to compress NAV discounts.
NB Global Floating Rate Income Fund for instance approved a managed wind-down in January 2023, which has significantly added to investment returns as the share was trading at a discount to NAV but capital distributions resulting from the sale of the company’s assets were made at NAV.
Overberg Asset Management’s private share portfolios have benefitted from holdings in Hipgnosis Songs Fund, Scottish Mortgage and NB Global Floating Rate Income Fund. The portfolios have also benefitted from the massive appreciation in Nvidia, which is the heaviest weighted share in Scottish Mortgage and Allianz Technology Trust. Both these investment companies are held in our private share portfolios and both trade at unusually wide NAV discounts of close to 10%, with significant opportunity to narrow.
2. Low-cost access to best of breed global investment teams: Investment companies provide the ideal structure for gaining exposure to alternative asset classes such as private equity and absolute return strategies. Alternative asset classes which add so much value to portfolios in terms of diversification and performance are often illiquid and so the closed-end structure of an investment company is the ideal structure for holding them. They are ordinary shares and traded daily on the London Stock Exchange.
3. Gearing: Investment companies tend to outperform rising markets due to the narrowing in NAV discounts but also due to their ability to use borrowed money to boost returns. If the investment company earns more than the interest paid on the loan, the gearing will boost investment returns. This is one of the reasons that investment companies tend to produce better returns than the market indices.
Since markets always tend to go up over the long-term, investment companies have a long-term history of outperforming. If you would like to participate in our unique global investment strategy, personally or via a trust or pension structure, please contact our experienced and dedicated management team for a free consultation and ensure your financial wellbeing. Since our establishment in 2001, Overberg Asset Management has developed a proven track record in global and domestic South African markets.
Local Report: South Africa’s Electricity Sector Transformation
By Francois Louw
Introduction: For years, South Africa’s electricity sector has struggled with inefficiencies, high costs, and unreliable service. Eskom, the state-owned power utility, has been at the centre of these issues, plagued by aging infrastructure, financial mismanagement, and operational challenges. The industry is undergoing a profound transformation, driven by economic challenges, regulatory changes, and a growing emphasis on renewable energy. This shift is reshaping the landscape of energy production, distribution, and consumption in the country, with significant implications for businesses, consumers, and the overall economy.
The Latest Data: In Q1 2024, Eskom’s Energy Availability Factor (EAF), which measures its percentage of maximum energy generation, was 53%, improving to 64% in Q2 to date, still below the near-term target of 65% and long-term goal of 75%. This improvement is mainly attributed to several major units returning to operation and increased imports of lithium-ion batteries and solar panels. These factors increased electricity supply and relieved levels of demand, leading to fewer planned and unplanned outages, and an overall reduction in levels of loadshedding in 2024. As of June 2024, there have been 1656 hours or 69 full days of loadshedding. In 2023, South Africa experienced 289 full days of loadshedding for the year. Measured in gigawatt hours (GWh), there has been cumulative loadshedding of 2,750 GWh compared to 10,092 GWh in the same period in 2023.
The Move to Renewable Energy: Overall demand for Eskom-generated electricity has been on a steady decline path since the start of 2023. This decline can be attributed to various challenges that South Africans have had to deal with like sluggish economic growth with industries producing less, electricity prices rising at exponential rates, and persistent loadshedding. In response to the above-mentioned challenges, there has been a significant shift towards renewable energy and self-generation. Businesses and households are increasingly investing in solar photovoltaic (PV) systems, battery storage, gas for cooking, and solar hot water systems. This trend is driven by the need for reliable, cost-effective energy solutions and is supported by favourable government policies.
The Tax Incentive Fuelling Renewable Investments: Section 12B of the Income Tax Act was introduced in 2016 to incentivise private companies which invest in renewable energy, with a focus on solar power. Under this section, the costs of solar projects smaller than 1MW are fully tax-deductible in the first year of production. Projects larger than 1MW are deductible over three years, at 50% in the first year, 30% in the second, and 20% in the third. Section 12B did not receive enough traction to have a meaningful impact, so Finance Minister Enoch Godongwana introduced Section 12BA in July 2023 as an enhancement. This section provides for a 125% tax deduction for companies which installed new projects from 1 March 2023. Assets that qualify for this deduction include solar panels, battery inverters, battery back-up systems, and battery units. Important rules to note are that this incentive only applies to projects installed up to 1 March 2025, and a company cannot claim the deduction under both sections mentioned above.
Kenhardt: The Largest Solar Project in the Country: A new hybrid solar photovoltaic (PV) battery storage facility, spanning an area equivalent to 1,500 soccer fields, was unveiled in the Northern Cape last year. This facility, among the largest globally, is the first from government’s 2020 Risk Mitigation Independent Power Producer Procurement Programme (RMIPPPP) to feed electricity to the grid. The output of this 3-tiered project far surpasses that of others with a combined capacity of 540MW of solar PV and 225MW of batteries with 1.1 GWh of storage capacity. It is currently dispatching 150MW to the grid daily under a 20-year agreement with Eskom. Operational since November 2023, the project underscores the effectiveness of renewables as a stable power source. Scatec, headquartered in Norway, has developed several renewable energy projects in South Africa, including a 75MW solar plant in Kalkbult, and continues to leverage South Africa’s abundant solar and wind resources to provide affordable, sustainable, and secure energy. Several other major renewable energy plants have come online in recent years, especially in the Northern Cape.
Grid Capacity: The current infrastructure, particularly high voltage lines in the Western Cape, Eastern Cape, and Northern Cape have reached maximum capacity and it is now impossible to add additional power from renewable sources to the grid. These regions, rich in natural resources, have numerous renewable energy projects ready to generate electricity but are hindered by insufficient grid capacity and access. Eskom estimates that expanding the grid to accommodate new electricity generation will require an investment of at least R200 billion over the next decade. This expansion includes 14,200km of high-voltage lines and 170 transformers. Neither Eskom nor the government currently possesses the necessary funds for this investment.
Economic Growth: In response to the increase in renewable energy projects and the reduction in loadshedding, the South African Reserve Bank has recently revised its 2023 prediction regarding the impact of loadshedding on GDP growth for 2024. In April 2023, the Bank forecast that loadshedding would reduce 2024 GDP growth by 0.8 percentage points, however, it has now adjusted this figure to 0.6 percentage points. Given that the country only experienced 0.6% GDP growth in 2023, this revision is significant. Alongside other factors, this adjustment could potentially attract both local and foreign investors back to the South African market and the JSE.
Conclusion: South Africa’s electricity sector is at a pivotal point, undergoing a transformation driven by economic necessity, regulatory reforms, and technological advancements. The shift towards renewable energy, structural unbundling, and market diversification is reshaping the energy landscape, offering new opportunities for businesses and consumers. As the country navigates this transition with all its challenges, the focus will be on building a more resilient and sustainable energy system that supports economic growth and improves the quality of life for all South Africans. Sources: MoneyWeb, News24, Daily Maverick, Standard Bank Research Portal
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The Bottom Line: Innovation and the Magic of Compounding
By Carel La Cock
The oldest investment trust listed on the London Stock Exchange can trace its beginnings back to the surging demand for rubber at the advent of the car industry. Following the Panic of 1907 when the New York Stock Exchange fell nearly 50% from its peak, credit markets dried up and realising the opportunity to lend to rubber plantations in Asia, Colonel Augustus Baillie and Carlyle Gifford established The Straits Mortgage and Trust Company Limited that would ultimately become the behemoth: Scottish Mortgage Investment Trust (SMT), a constituent of the FTSE100.
Baillie Gifford & Co, the investment management company that stewards SMT, oversee total assets in the fund of £16.67bn as at the end of February 2022. Outgoing manager, James Anderson, defined his career with early investments in Amazon and Tesla, which propelled the fund to cumulative growth of 696.8% in the last 10-years, compared to 220.4% for its benchmark, the FTSE All-World Index. Anderson’s investment philosophy has always been based on the belief that technological improvements will drive innovation and that even picking a small number of these successful future companies and holding on to them long enough to let the magic of compounding work, will lead to exceptional returns for clients. Tom Slater, co-manager since 2015, will take over the reins at the end of April and believes that it matters less failing to sell the holdings you should sell, than selling the holdings you should not sell. When they go long on investments, they remain long offering support as patient investors often nurturing private holdings until they go public.
After a stellar performance in 2020 which saw net asset value (NAV) grow by 106.5%, 2021 was more subdued by its own standards, up only 13.2%. This year the share price has come under severe pressure from rising inflation and the rising interest rate used in discounting long duration income flows on many of the growth stocks in its portfolio. Moderna, the manufacturer of Covid-19 vaccines and the largest holding in the portfolio at 8% is down nearly a third year to date, while Tencent, the Chinese e-commerce giant, at 4% of the portfolio is down nearly a fifth this year. Others in the top five holdings: ASML (-13%), Illumina (-9.6%), Tesla (-13%) and NVIDIA (-10.4%) have all been downgraded due to expectations of a steepening yield curve.
Is now the time to panic and if not now, then when? Geopolitical risk is at an all-time high, the US federal reserve has just hiked interest rates for the first time since 2018 and global inflation is running rampant while oil and gas prices have spike on supply fears. However, listening to manager, Tom Slater and deputy manager, Lawrence Burns discuss the current environment and the outlook for the portfolio in a recent investor presentation, you don’t get the sense that now is the time to panic, or indeed ever. Their strategy is long-term, and they have positioned the fund to participate in structural changes and technological advances in society. They have incredible deal flow built on decades of strong relationships and a reputation for stability and patience. Entrepreneurs are keeping companies private for longer and having early access to investment in these opportunities often leads to extraordinary returns.
As for its current top holding, asked if Moderna is a “one-trick-pony” with reference to the major windfall from the Covid19 vaccine, but recently downgraded as investors see the end of the pandemic and the Covid-19 vaccine franchise, Lawrence answered “Moderna is a one trick pony, but that one trick is a broad and important one and that trick is mRNA.” The biotechnology behind the Covid-19 vaccine is a powerful one with programmes to cure zika, HIV, cancer and a range of other ailments making the recent windfall unlikely to be a once-off.
Regarding the tightening of regulation in the Chinese technology sector and its impact on Tencent, the team thinks that the Chinese government is ahead of the curve in terms of regulation and that democratic western nations will eventually implement similar regulatory changes. They believe that companies that “go with the grain of society” and who are aware of their broader impact on society will find it easier to prosper. In this regard, Chinese tech companies are further along the route of enlightenment.
Lastly, Tom Slater does not agree that higher inflation and rising interest rates should lead to lower valuations on growth stocks. He cautions investors to also consider the impact of pricing power on some of these high growth companies as they become market leaders in their field. Therefore, with higher expected future inflation, one should also adjust the future cash flows that will yield a better current valuation. Looking past the current volatility, the fund has invested in some ground-breaking technology and the managers are excited by the intersection of computing power and biology calling the opportunity set “large and varied” They have 49 investments in private companies, and it is not difficult to imagine the next Amazon and Tesla coming from that pool.
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