Exposed: Many professional analysts, fund managers don’t understand A and B share structures

If you’ve ever marveled at the number-crunching by stockbroking analysts and fund managers, you can take off your rose-tinted glasses now. South African hedge fund manager Maurice Shapiro can reveal that many don’t even know their As from their Bs when it comes to listed property share structures.  

Yet, broking analysts are happily churning out buy and sell recommendations based on their poor understanding of how shares actually work. And, those well-paid fund managers who are investing money on our behalf are making investment decisions on flawed models.

Maurice, chief quantitative fund manager at Alternative Real Estate, would prefer not to name some of the analysts who clearly aren’t on top of their game – for now. “The issue is more general and affects most of the analysts and fund managers,” he told me when I asked him why he did not want to “name and shame”. Maurice did show me a sample, though, from an analyst working for a large South African bank. 

Maurice is making good money by taking advantage of these errors. He reckons you should do the same. – JC

By Maurice Shapiro

The listed property sector in South Africa, has a number of interesting dynamics and structures. One of particular interest is the A and B structure some of the listed funds have adopted.

What is specifically thought-provoking  is that each different company has adopted a slightly different A and B structure.

The A and B structure was first conceived by Gerald Leisner in the early 2000s when he was CEO of Apex-Hi. The idea was to give investors of different risk appetites the opportunity to choose between an A units (the safer more secured share) or B units (the riskier share but having bigger potential upside).

Each of the A/B companies follow a similar but different structure, with A units getting the first portion of income and B units getting the remaining income.

Hedge fund manager Maurice Shapiro is a whizz with numbers. He's spotted many professional analysts and fund managers who aren't getting their assumptions right – and he's making money out of their errors.
Hedge fund manager Maurice Shapiro is a whizz with numbers. He’s spotted many professional analysts and fund managers who aren’t getting their assumptions right – and he’s making money out of their errors.

If we fast forward to today, we know have 6 A / B companies (AWA,AIA,DIA,FFA,HPA, SGA) listed in the South African Property Sector (SA REIT Sector).

Most, recently Arrowhead Properties (Gerald Leisner is this company’s CEO) reported on the financial results ending Sept 2103, they were able to grow earnings by 12.36% for combined A&B units, above market expectations of 10%.

What is more interesting is that their A/B structure ensured that B units grew their distribution by over 30%.

Arrowhead’s unique A/B structure safeguards A units as they receive the first 60 cents of distributable earnings and B units receive the remaining distributable earnings until the total distributable earnings is above 120 cents. Thereafter they split the distributable earnings equally.

As an example, last year Arrowhead’s combined distribution was 113.01 cents, split with A units receiving 60 cents and B units the remaining 53.01 cents. Arrowhead’s management expect combined distributable earnings to be above 127 cents, which would mean the crucial 120 cent level will be breached with A and B units both receiving above 63.5 cents.

What may confuse investors is that  A units distribution will grow from 60 cents to 63.5 cents (a 6% growth) while B units distribution will grow from 53.01 cents to 63.5 cents (a 20% growth).

Now this may all sound confusing, and you would be correct as we have recently seen Analyst reports showing target prices for AWA above 8.00 with a buy recommendation, yet the same analysts have a target price for AWB around 6.50 with a sell recommendation.

The irony is that now that the crucial 120 cent level will be passed next year both AWA and AWB receive the same income stream and should have very similar target prices, possibly a small premium should be paid for AWA as they do have downside protection, but this premium is only worth maybe 5 to 10 cents not a 1.50 price difference.

How does this happen, when there are supposedly expert professional analysts following this company? When questioning analysts on their completely incorrect targets, they defend themselves with their complex models and incorrect assumptions around different risks associated with A vs. B units.

At least we can be assured that they are constant in applying bad assumptions and misunderstood models  It is simply a case of analysts using “fancy” models with bad assumptions and little understanding on how these “fancy” models actual compare to reality i.e. Garbage in = Garbage out no matter how pretty the black box looks.

As a mathematician, I am always concerned with using models without applying one’s mind. We see similar misunderstandings in the pricing and analysis in other A/B unit structures, some of the companies have “guaranteed” 5% growth structures for the A units which makes them very similar to inflation linked bonds yet analysts continue to use the same models regardless of structure (which often under-prices the low risk nature of the A units).

Often the sum of the parts doesn’t always add up to the whole; i.e. if you valued the whole company as one entity you would get a different value than if you value each A and B unit separately.

This great confusion isn’t exclusive to analysts. We see fund managers misunderstand these types of structures and more specifically they use their “fancy” models to determine which stocks to purchase.

Often these models are dependent on index weights. These indexes rank companies according to market cap and have no differentiation between A, B or standard stocks. So often fund managers base their investment decisions on criteria that have little significance to reality.

Obviously an index tracker fund (ETF) doesn’t take these crucial risks between different structures into account – one thing you can be confident about is that an ETF/Index tracker Fund will guarantee you average returns.

On the upside all this confusion isn’t all bad. It allows astute investors opportunities to make great returns with little risk. We have profited nicely for our funds by merely applying our minds. So the next time you rely on an expert analyst for your research, maybe you should take a second look, apply your mind and determine if the research even makes sense.

Maurice Shapiro is Head Quantitative Fund Manager at Alternative Real Estate. Maurice holds a Bachelor of Science Honours (Advanced Mathematics of Finance). Prior to joining Alternative Real Estate, Maurice was a Director and Quantitative Analyst for a boutique hedge fund focused on both the local and international real estate sector. Maurice has experience in equity and debt capital markets, structured finance, asset management, derivative instruments, foreign currency denominated investment exposure and structured fund management experience. Maurice previously worked for African Life Assurance in the Actuarial Department.

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