Gabelli Value Plus+

Gabelli Value Plus offers exposure to value opportunities in US stocks trading at a discount to their value to an informed buyer...

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Disclosure – Non-Independent Marketing Communication

This is a non-independent marketing communication commissioned by Gabelli Value Plus+. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.

Gabelli Value Plus+

Summary

Gabelli Value Plus+ (GVP) aims to achieve strong total returns through investment in a portfolio primarily of US equities. Managed by GAMCO, GVP utilises a disciplined proprietary investment philosophy known as Private Market Value with a Catalyst™.

As we discuss under portfolio, this investment process focuses on both the intrinsic value and strategic premium that a company offers to a potential informed buyer. The team of over 40 analysts look to evaluate and understand stocks from a bottom-up perspective, and identify such opportunities where they also believe there exists a catalyst to drive this value realisation.

A continuation vote will take place on 30/07/2020, and shareholder votes must be submitted before 28/07/2020.

If the shareholders vote in favour of continuation, it is proposed that the trust could adopt new policies regarding an enhanced dividend payout, as we discuss under the Dividend section. This would significantly enhance the levels of distributions were it to be adopted.

Similarly, proposals supporting continuation suggest a lower management fee be adopted (see Charges), and that buybacks be undertaken if the discount exceeds 10%. As we detail under Discount, the board in the previous financial year had in any event tended to support the share price with buybacks when the discount widened past this level.

Performance has been undoubtedly challenging, with both the small cap and value factors, which the trust’s process inherently lends itself to, facing severe headwinds over most of the period since the trust’s launch. As we note under the Performance section, changes in inflation expectations will likely continue to support or weigh on near-term returns.

Kepler View

If the concern of shareholders pushing for a wind-up is over performance, this is understandable looking backwards. However, looking backwards is probably not optimal for understanding prospects for returns. GVP has operated in an environment where stock leadership has been increasingly narrow, and increasingly amongst the largest companies. Some factors, such as the rise of passive investing, have helped contribute to this of course, as has the perception of a move to a ‘new normal’ in the wake of the Covid-19 pandemic and policy.

The question for shareholders is whether and to what extent these factors will persist indefinitely. As we have suggested here, it may be too soon to expect a durable recovery in small caps yet, and further patience may be required. And a higher discount rate (i.e. higher nominal interest rates) would, in our view, potentially help to catalyse and initiate a sustained value recovery. But just because an imminent reversal may not be in the offing (and the word ‘may’ is pertinent here), this does not necessarily mean there does not remain a long-term case for allocation to small-cap value. We would suggest that ultimately US economic dynamism may indeed depend on such a reversal to the favour of smaller companies, and will ultimately require higher interest rates. ‘Should’ is, of course, not the same as ‘will’. But the continued outperformance of large-caps to perpetuity is ultimately likely unsustainable within the current social contract.

bull bear
Should benefit if inflation materialises Near-term headwinds to smaller companies likely remain
More immediate value realisation potential if trust discontinued, likely favourable dividend policy if not If vote is in favour of continuation, several large shareholders will likely look to exit weighing upon the discount
Differentiated portfolio and returns profile to typical US equity vehicle Challenges to relative returns from market structure remain

Portfolio

Gabelli Value Plus+ (GVP) aims to maximise total returns through investment in US companies with a disciplined value approach first developed and implemented in 1977. Whilst value remains a key component of the team’s investment thesis for any particular stock, the process also emphasises identifying a catalyst to a stock rerating which will allow the inherent value to be realised over time.

GVP is very much managed on a team basis, with a wide pool of analysts utilising the same analytical framework. This process emphasises a value assessment predicated on the value of a company to an informed buyer (for example, a competitor company). From this analysis they developed a ‘Private Market Value’ (PMV) for the company, deemed to be the sum of the intrinsic value of the company and the strategic premium it would offer to a potential buyer. Having identified a company or companies trading at a discount to this PMV, the analyst seeks to identify a catalyst which might spur a valuation rerating.

This methodology (Private Market Value with a Catalyst™) is proprietary to the Chief Investment Officer of GAMCO, Mario Gabelli, and has been utilised by the firm since 1977. GVP was itself launched in February 2015 with a view to providing UK investors with better access to this process and strategy.

Such an investment process focuses very much on absolute performance as opposed to relative returns, and little reference is made to the wider US stock market or the nominal benchmark. As the team is seeking companies trading at a significant discount to their intrinsic value, stocks with lower levels of broker coverage tend to offer greater opportunities and the trust is thus skewed towards smaller companies, where pricing inefficiencies are more common in their view. A relative lack of broker coverage has been exacerbated by recent trends within the industry which has seen many of the major banks withdraw analyst coverage of smaller companies. The managers of GVP take the view that, as well as offering greater pricing inefficiencies, smaller companies often offer greater long-term growth prospects relative to their large cap peers.

weightings by market cap vs russell 3000

Source: GAMCO

Even relative to smaller companies, however, the process tends to result in a distinct and differentiated portfolio, with GVP exhibiting an active share of c. 97.9% to the Russell 2000 Value index as of 30/06/2020 (Source: GAMCO).

Historically, the focus on returns in an absolute sense (as opposed to relative to the wider index), coupled with the value process, tends to mean the investment strategy (as represented by wider GAMCO strategies) has outperformed in falling markets. This was not the case in Q1 2020, as the relatively indiscriminate nature of the sell-off meant the fundamentally defensive characteristics of many companies went underappreciated. Instead, liquidity proved a greater predictor of relative performance, with market makers holding relatively low amounts of many stocks and adjusting their prices sharply on the backs of relatively low trading volumes.

Idea generation is very much driven from the bottom-up, with a team of over 40 analysts undertaking stock-specific research with the aim of identifying companies with a suitable ‘margin of safety’. Stocks will be introduced only when there is at least a 30% discount to what the team deems the private market value of the company is at the time of purchase. Conversely, positions will typically be exited when the stock reaches or exceeds their identified private market value.

Ordinarily this occurs following a catalyst, and the team looks to ensure there is a catalyst in the offing to drive returns. These can be either ‘hard’ or ‘soft’. ‘Hard’ catalysts are typically those pertaining specifically to the company, where the analyst observes corporate activity in the offing that can drive a valuation revaluation by the wider market. ‘Soft’ catalysts relate more to wider sector or macroeconomic observations, and can include perceived opportunities from sector consolidation amongst fragmented sectors, amongst other considerations. These two broad categories cover a wide range of potential scenarios, encompassing possible drivers of value realisation such as regulatory changes, industry consolidation or corporate spin-offs. Whilst particular catalysts may take prominence at any one time due to the broader market and economic backdrop, overall the team looks to ensure the portfolio is spread amongst a variety of different catalysts over time.

Unsurprisingly given the focus on intrinsic value, the valuation of assets and items both on and off the balance sheet is considered an important component of stock analysis, as well as assessing cash flows and other factors. Particular emphasis, however, is placed upon identifying ‘strategic values’ that a company may hold to a potential acquirer, an intangible assessment of factors beyond the replacement value of a company’s assets. This is viewed as also having the additional benefit of helping the team avoid ‘value traps’ in poor quality companies which are optically cheap but where poor fundamentals leave the company in a weak market position operationally. Such companies are less likely in their view, for example, to be subject to acquisition bids from competitors who can ultimately take their market share through superior operational performance.

Gabelli as a house have extensive experience in merger arbitrage, and seek to utilise this within GVP (as well as operating a separate merger arbitrage product listed in the UK, Gabelli Merger Plus+). This is incorporated into GVP, though this strategy now accounts for less than 10% of the portfolio. This allocation is invested in merger-arbitrage strategies which target a rate of return of around 200-300bps over 3-month LIBOR. As these positions are taken in companies subject to takeover bids at a discount to the agreed price (with the discount arising on remaining concerns over the deal not being completed), the returns generated from this strategy should be differentiated and agnostic to wider equity market performance. However, bond market performance impacts the amount of return that can be generated, with lower yields a headwind to the absolute level of gains that can typically be generated.

As we discuss under the Performance section, a reduction in inflation expectations (concomitant to inflation expectations) is likely to be a headwind to the wider relative performance of the GVP equity book. Conversely, the emphasis on present value in Gabelli’s stock analysis means that, were inflation expectations to rise, GVP would likely stand to benefit on a relative basis.

Whilst sector exposure is an output of the stock selection process as opposed to a targeted consideration, the value factor considerations incorporated into the process means the trust has fairly consistently underweight to the technology sector, and overweight to industrials.

sector exposure vs russell 3000

Source: GAMCO

Although the environment for value investors has been challenging in recent years, the managers of GVP remain positive on the long-term case for value investing and have noted their agreement with recent research from the quant-based AQR Capital Management that suggests evidence remains that value-factor investing can produce stock-specific value. The managers note that returns remain increasingly driven by a small subset of large-cap stocks, but that historically similar instances have been experienced and ultimately have reverted to the favour of smaller companies.

Gearing

The managers of GVP have the ability to gear the trust to 15%, but have not yet availed themselves of this facility. They believe the structural advantages of a trust format are, in large part, the ability to access less liquid small cap opportunities, as opposed to the ability to gear market returns.

Returns

Whilst the investment process employed within Gabelli is a replication of a strategy that has proven successful over the long-term (since 1977), GVP’s lifespan thus far has coincided with adverse conditions for both small caps and value stocks. Since inception on 19/02/2015, GVP has delivered NAV and share price returns of c. 22.6% and 6.2% respectively. This has represented significant underperformance of the Morningstar Investment Trust North America peer group over the same period, which has seen NAV and share price returns of c. 70.3% and 66.4% respectively, whilst the Russell 2000 index (as represented by a passive vehicle) has delivered returns of c. 50.9%.

cumulative returns since inception vs peers and russell 2000

Source: Morningstar

Both size and style considerations have been a headwind over this period, with the S&P 500 delivering returns of c. 107.5% over the same period, an outperformance over the Russell 2000 of c. 56.6%. We can also see the stylistic headwind in the performance of ‘smart beta’ ETFs within the Russell 2000, with a ‘Value’ factor index returning c. 25.5% against a ‘Growth’ factor index return of c. 76% over the same period.

The underperformance of ‘value’ relative to ‘growth’ over this period has in large part due to market level valuations of future cash flows against present values. As inflation and interest rate expectations ground lower over this period, this increased the perceived value of future cash flows, to the detriment of companies exhibiting more immediate value (which comprise GVP’s portfolio). We can see the impact of the inflation environment on the portfolio in the chart below.

In this, we have looked at changes in the US 5 year 5 year inflation expectations over rolling six month periods against the relative NAV returns of GVP to the peer group over the same period. Whilst there have been periods where the impact is decidedly slighter, sharp changes and clear trends in environments have clearly had an impact upon the direction of relative returns. Whether the ongoing, unprecedentedly large stimulus support results in inflation or not will likely prove important to relative returns for Gabelli (and value strategies) in the near term.

rolling six-month nav returns relative to peers vs six-month change in 5yr5yr us inflation expectations


Source: Morningstar, St Louis Federal Reserve

Over the longer term, however, the managers note that their thesis for a value recovery is not dependent on higher interest rates or inflation. Instead, they believe that both small caps and value stocks will be well positioned to benefit from a confluence of factors, including increased infrastructure spending, reshoring of production, and relaxation of financial regulations.

Given the duration of these stylistic and market cap factor headwinds, a reasonable criticism could be aimed at the managers for perhaps not moderating their approach somewhat to reduce the impact of this in the face of severe momentum headwinds, themselves driven by a broader macro framework.

However, the extremely narrow leadership of much of stock returns over this period suggests that such style drift would likely have been meaningless. Market performance has been dominated by a (technology and growth heavy) cadre of very large companies, and the equal-weighted S&P 500 returns have sharply lagged those of the market weighted over this period (i.e. the largest components have outperformed). So tactical style drift would likely have necessitated a complete disavowal of the investment process to significantly offset the wider headwinds faced. We can see the performance of GVP’s NAV on a relative basis since launch, and that of 1) the Russell 2000 vs S&P 500 (i.e. small vs large cap), 2) S&P 500 equal weighted vs market weighted, 3) and the Russell 2000 Value vs Growth.

We can see that underperformance has significantly accelerated in the last 18 months or so. It is doubtful this kind of exponential acceleration of underperformance can persist, but a mean reversionary recovery in small caps and value should not be assumed. As noted above, in the near-term at least a value recovery probably requires higher nominal interest rates.

Whilst there are potentially grounds for optimism for the long-term structural outlook for small caps at this time, there remains doubts over the nearer-term given the factors driving relative returns at this time, as we have detailed here. Nonetheless, should these headwinds abate or reverse, GVP could see its relative fortunes improve.

cumulative relative nav returns to peer group average, vs size and style factors relative performance

Source: Morningstar

Dividend

GVP currently yields c. 0.9% (as at 13/07/2020) on the basis of the declared 2020 dividend. Dividends are regarded by the managers as a component of the total return, albeit they are likely to comprise a smaller element of returns to shareholders than returns from capital. Dividend streams are incidental, however, rather than targeted, and are likely to be variable.

The board has recommended a final dividend of 1.0 pence per share for 2020, to be paid on 14/08/2020 (with the trust going ex-dividend on 16/07/2020). This level of dividend remains well covered by a revenue reserve amount to c. £1.3m prior to the payment of the 2020 dividend.

However, in the wake of the announcement of the forthcoming continuation vote, Associated Capital Group (who held c. 27% of shares and voting rights as of 31/03/2020) has proposed the trust move to a model whereby dividends are hiked to a 5% yield.

As Associated Capital Group, which is chaired by GAMCO founder Mario Gabelli and was spun off from GAMCO five years ago, is the largest single shareholder in GVP it will be influential. Furthermore, as other leading shareholders are on record as opposing continuation, it does not seem feasible that trust will survive without a change in its dividend policy.

Therefore, it might reasonably be expected that dividends will sharply rise and be paid out of capital if the trust survives the forthcoming continuation vote.

dividend and revenue per share

Source: Gabelli, AIC

Management

The management team is led by Mario and Marc Gabelli, who are supported by a team of six other portfolio managers and over 40 research analysts, between whom there is more than two centuries of professional experience.

GAMCO was founded by Mario Gabelli, who pioneered the "PMV with a Catalyst™" approach, in 1976 as an institutional research firm. It is now a publicly-listed company in the US that employs roughly 200 individuals, oversees assets worth c.$35bn and manages around 2,000 separate accounts for institutions and high-net worth individuals. It runs over 30 open-ended funds and 16 closed-ended funds, making it one of the largest closed-ended players in the US, with c.$7.5bn AUM. Outside of the US, it has offices in London, Tokyo and Shanghai.

Though not particularly well-known in the UK, Gabelli is in ‘household name’ territory across the Atlantic. GAMCO Investors, which is the investment manager for the trust, was launched by veteran value investor Mario Gabelli in the mid-1970s and has grown to be one of the leading fund management groups in the US with assets of $40bn under management and roughly 200 investment professionals on the rota.

Discount

GVP presently trades on a discount of c. 8.8% (as of 13/07/2020). This is wider than the median level of discount seen over the trust’s entire history, which has been c. 7.3%, but is narrower than the median discount level of c. 10.9% seen over the past twelve months. As we have discussed under Performance, US small caps have struggled in recent years and the widening in recent months of the discount level relative to the historic median is unsurprising in this context.

Over the previous financial year to 31/03/2020 the board bought back 1,424,500 shares at a weighted average discount of c. 12.4%. In 2019 a tender offer for up to 14.99% of outstanding shares was proposed, but has been delayed as a result of the forthcoming continuation vote. Similarly, no buybacks have been undertaken thus far in the current financial year, which we would attribute to the imminent continuation vote.

Ahead of the forthcoming continuation vote, Associated Capital Group (ACG, a 27% shareholder spun off from GAMCO five years ago and chaired by Mario Gabelli), has proposed that going forward buybacks be engaged if the discount exceeds 10%. As ACG is the most significant voice amongst the share register supporting continuation at this time, it would seem likely this will be undertaken if GVP shareholders ultimately vote in favour of continuation. However, this may prove challenging if certain large shareholders who have voiced their support of discontinuation subsequently opt to sell.

discount/premium

Source: Morningstar

Charges

The OCF on the trust is 1.24% with management fees of 1% based on market price (Source: JPMorgan Cazenove). However, management fees would seem likely to be lowered to 0.85% based on net assets should the trust survive the upcoming continuation vote. Management fees are taken 75% from capital and 25% from income. The size of the trust (with net assets of £116m) means that the OCF is amongst the higher in the sector, and compares to an AIC North American sector average of 0.38% (though this figure is skewed by a very large low outlier). The KID RIY figure is 1.29%, compared to a sector average of 0.93%, although we caution that methodologies vary.

ESG

The manager believes that it is in shareholders’ interests to consider human rights issues, environmental, social and governance factors when selecting and retaining investments, but this will not be a dominant input to stock analysis.

Fund History

Related Research

Disclaimer

This report has been issued by Kepler Partners LLP.  The analyst who has prepared this report is aware that Kepler Partners LLP has a relationship with the company covered in this report and/or a conflict of interest which may impair the objectivity of the research.

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