National Post (National Edition)

Mind the gap at Income Financial Trust

What’s behind disconnect between trading price, NAV?

- BARRY CRITCHLEY

FOff the record or some it’s an untenable longrun situation, a closed-end fund that trades at a hefty premium to net asset value. In the short run, the market is used to situations in which funds trade at either a slight premium or discount to NAV.

But matters seem different at Income Financial Trust, a closed-end fund taken public in early 1999 with the proceeds used to invest in financial sector companies. The fund also wrote covered call options on stocks it owned. At the time the plan was for the fund to wrap up in 10 years. That didn’t happen, thanks to two mergers with funds, also managed by Quadravest Capital, and to extending the terminatio­n date.

At last count (June 30, 2017, when the fund issued its semi-annual report) NAV stood at $10.82. (The fund, which has 2.323 million units outstandin­g, is home to $25.1 million net assets.) On that day in June the units traded at $16.32.

So what’s behind the disconnect between trading price and NAV, a disconnect that emerged about two years back? Here’s another way to show the recent disconnect. Since December 2012, NAV per unit is up by 25 per cent (to $10.82 from $8.65) yet the trading price has almost doubled (to $16.32 from $8.52). On Nov. 15, the latest date for which informatio­n is available, NAV was $10.61 while the units traded at $19.21. The units closed Friday at $19.81.

One theory has to do with the distributi­on policy change made in late 2013, the second in its history. The original goal was to pay out monthly an annual amount equal to 8.50 per cent of the initial $25 a unit purchase price; in July 2008 the policy was amended to pay out 8.50 per cent, again on a monthly basis, but based on the fund’s “net asset value per unit calculated as at the end of the preceding month.”

In 2013, the policy changed so that the Trust “now endeavours to pay a distributi­on in any month equal to a 10 per cent annualized rate on the volume weighted average trading price of the units on the TSX over the last three trading days of the preceding month.”

Such a distributi­on policy is not the norm, but it was also put into place at two other Quadravest funds: Canadian Banc Corp. (implemente­d in September 2013) and at Prime Dividend Corp. (implemente­d in July 2014).

Unlike Income Financial, those two funds are split-share issuers — meaning an entity with a capital share and a preferred share. At both funds the capital shares are the beneficiar­ies of the new distributi­on policy. But the Income Financial situation hasn’t repeated itself with the two split share issuers where the trading price is near the combined NAV.

Because of the policy change, Income Financial unit holders have received steadily increasing dividends, with the latest 16.158 cents per unit payable on Dec. 8. Since inception they have received $31.

But the vast bulk of the distributi­ons have been in the form of return of capital. For the first half of 2017, eligible dividends were 5 cents per unit, while return of capital was 73 cents per unit. A return of capital is not cash but lowers the holder’s adjusted cost base, which means when the investment is sold the potential capital gain gets larger.

Another theory is that investors see the 10 per cent sticker and load up, not being fully aware of the situation. But we know the situation is not good for short sellers. As of Nov. 15, about eight per cent of the units outstandin­g were shorted.

We were unable to reach Quadravest.

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