Sometimes, I write about securities I believe could be under-valued. Other times I write about those that are simply unusual or exceptional in some way. Sometimes, it’s a little of each. Fondul Proprietatea S. A. is one of these. “FP” is one of the world’s most unusual publicly-traded securities, worth examining for the history lessons it offers as much its investment potential.
Brutal autocratic regimes seem to be a hallmark of human society. Despite our advancement as a species, we have not yet learned how to prevent their rise to power. Human beings continue to be susceptible to the promises of demagogues, only to wonder “what happened?” when these regimes almost inevitably turn to brutality and mass murder. Fortunately, many of these totalitarian governments are inherently unstable, and many populations eventually successfully depose them. Following a return to some semblance of democracy, some societies have made attempts to compensate the victims of these regimes.
One commonly followed approach is issuing affected citizens securities that are exchangeable for state assets, including state-owned real estate and operating companies, when these assets are sold to the public. Bill Browder famously profited handsomely by buying up these securities in Russia following the collapse of the Soviet Union. Other former members of the Soviet sphere of influence pursued similar programs after the fall of communism. In fact, investors can still purchase Hungarian Compensation Notes on the Budapest Exchange. Did these compensation schemes work? I will leave the particulars to academics, but most of these programs appear to have played out in predictable fashion, with many poorer and less educated recipients selling their claims to more sophisticated, deep-pocketed investors for a pittance in order to meet their urgent material needs.
Romania pursued a slightly different tack after the overthrow of Nicolae Ceaușescu in 1989. The communist dictatorship that ruled the country from 1945 to 1989 had nationalized hundreds of thousands of properties which could not easily be returned to their owners. To compensate the former owners, Romania created the Fondul Proprietatea or “Property Fund” in 2005. The FP was to be a corporate entity that would hold state assets for distribution, including shares in state-owned enterprises. The entity would be managed to maximize its value and distribute its assets to owners over time. In 2010, Franklin Templeton became FP’s portfolio manager after a global search process. Shares of FP became tradable in Romania 2011 and a few years later, depositary receipts were listed in London.
Right from the start, FP shares traded at large discounts to net asset value. This discount eventually attracted the attention of famed fund manager Paul Singer, who pushed FP’s managers to sell off portfolios holdings and buy back deeply-discounted shares. FP has continued to conduct regular share repurchases and tender offers, leading the discount to net asset value to diminish over time. A portion of Franklin Templeton’s compensation actually depends on maintaining a discount to net asset value of 15% or less, so FP’s manager is incentivized to narrow the discount. (Working against this incentive may be the 0.60% annual management fee on fund assets that Franklin Templeton receives, which obviously rewards them for managing a larger fund.)
Today, FP’s discount to net asset value stands at around 18%. The discount was much higher in March of this year, when many other closed-end investment funds also traded at gigantic discounts to NAV. FP’s investing results have been generally good, with net asset value rising 122% from January 25, 2011 to June 30, 2020. Since 2011, FP has returned an average of 16% of its capital to shareholders each year through a combination of tender offers, buybacks, and distributions.
In Fondul Proprietatea we have a rather large investment vehicle trading at a significant discount to net asset value. Historically, this net asset value has grown at a healthy rate, bolstered by the fund’s aggressive capital return efforts. There is every indication this capital return program will continue based on FP’s stated cash distribution policy.
But what about the downsides? Unfortunately, there are a few.
The first is taxation. The US government makes investing in foreign non-operating companies and funds a major headache come tax season. I am absolutely not any kind of tax authority so I will not speculate on exactly what kind of tax and paperwork burden that owning FP could create for American investors. Another major issue is the makeup of the fund itself. Over time, the fund has gradually sold off its publicly-traded liquid holdings and has grown more concentrated in a small number of private assets, mostly infrastructure companies controlled by the Romanian government. These assets include Hidroelectrica, a hydroelectric power giant; ENGIE Romania, a natural gas distribution monopoly; Bucharest Airports, and Constanta Ports. Without a trading market, the valuations of these assets are “squishy,” subject to numerous assumptions. There are some indications that Hidroelectrica may pursue an IPO in the near future. Given that Hidroelectrica was 46% of FP’s total assets at June 30, an IPO would provide much greater clarity on FP’s net asset value as well as improving its liquidity. Fund owners must hope that the Romanian government pursues public offerings or sales of the fund’s other private assets as well. Obviously, anyone with a dim view on these particular assets or on the economic future of Romania may want to steer clear.
Fondul Proprietatea provides a wealth of information to current and potential owners – in English!
Alluvial Capital Management, LLC does not hold Fondul Proprietatea S.A. securities for clients. Alluvial Capital Management, LLC may hold any securities mentioned on this blog and may buy or sell these securities at any time. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at firstname.lastname@example.org.