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Magellan's new High Conviction Trust under the microscope

Michael Malseed  |  06 Sep 2019Text size  Decrease  Increase  |  
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This article is for background information only and is not a recommendation to subscribe to the offer. Investors should carefully read the offer document, seek financial advice, and form their own view.

Following on from the highly successful listing of Magellan Global Trust (MGG) in 2017, Magellan (MFG) recently opened the initial public offer for the Magellan High Conviction Trust (MHH).

This new vehicle will replicate the unlisted Magellan High Conviction strategy, which has been in operation since July 2013.

There are generous incentives available for existing investors in MGG, MFG, and the unlisted Magellan High Conviction Fund (Eligible Vehicles) in the form of bonus units (or loyalty units) equal to 7.5 per cent of allotted subscriptions up to $50,000 for each Eligible Vehicle. Subscriptions in excess of this amount can be made in the General Offer.

Investors with no existing holdings in the Eligible Vehicles can participate in the General Offer and receive bonus units equal to 2.5 per cent of their allotted subscription.

Magellan is covering all the costs of the offer, which is commendable, and will also fund a 5 per cent discount on the dividend reinvestment plan.

Despite these features, investors should carefully consider whether the underlying investment strategy is suitable to them. Given the significant stock concentration of the strategy, we believe Magellan High Conviction is best used in moderation, as part of a more broadly diversified equities portfolio.

The Magellan High Conviction Trust will be a closed-end, listed version of the Magellan High Conviction Fund. We have provided qualitative research on the unlisted Magellan High Conviction Fund since October 2018, and it currently has a Morningstar Analyst Rating of Silver.

This is a solid rating, suggesting the strategy has strong investment merit, but there are caveats. The strategy is a riskier proposition than the core Magellan Global fund, which currently enjoys our highest Morningstar Analyst Rating of Gold.

Whereas the core Magellan Global strategy holds 20-40 names, carefully balanced between growth, volatility, and drawdown risk, Magellan High Conviction selects only the team’s highest-conviction ideas, typically holding only eight to 12 stocks.

Magellan High Conviction Strategy | Portfolio holdings at 30 June 2019

Magellan High Conviction

Source: Magellan High Conviction Trust fund fact sheet: August 2019

Unlike the flagship fund, this strategy doesn’t have hard limits on aggregate portfolio risk but instead manages drawdown risk by allowing up to 50 per cent to be held in cash. The manager’s track record on this strategy since its inception is strong, but it hasn’t been tested in a bear market.

We expect the quality of holdings (and cash allocation) to provide some protection in volatile markets, but we have greater confidence that the flagship Magellan Global fund will provide a smoother ride.

Magellan High Conviction Trust will be a listed vehicle, so there are a number of other things to consider. It is a closed-end listed investment trust, so the price can deviate from net asset value depending on the liquidity of willing buyers and sellers at any point in time. It is not unusual for a listed investment trust to trade a premium or discount to the underlying NAV. 

Magellan has experience managing this issue for MGG and publishes an intraday indicative NAV, or iNAV, on its website to aid efficient price discovery. Magellan will also implement a standing buy back policy on MHH to support the share price if it trades at a meaningful discount, but liquidity at the best price is not always guaranteed. This is less of a concern for long-term investors, but caution needs to be exercised whenever a transaction is made.

The ongoing fee is also expensive relative to the average global equities manager. MHH will charge an annual management fee of 1.5 per cent plus a performance fee of 10 per cent on any return above a 10 per cent absolute return performance hurdle, subject to a high-watermark.

For context, the fee on Magellan Global Trust is 1.35 per cent per year with a performance fee of 10 per cent of any outperformance over the dual hurdles of the MSCI World Net Total Return Index (AUD) and the Australian government 10-year bond yield.

The unlisted Magellan High Conviction Fund has a couple of fee options –one identical to MHH, while Class B units have a base fee of 0.78 per cent plus a performance fee of 20 per cent of any excess return above the 10 per cent hurdle, up to a 2.22 per cent per-year cap. The average investment cost ratio of all global equities managers currently under Morningstar coverage (including passive funds) stands at around 0.9 per cent (including performance fees).

In conclusion, while the disciplined stock-picking skill of the manager gives the Magellan High Conviction strategy merit, its risk profile makes it a niche offer. Investors should carefully consider this investment in the context of their portfolio’s overall risk characteristics before making a decision on this offer.

is a Senior Analyst in the manager research team at Morningstar.

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