In addition to my recent comments on Foresight 4, it’s worth covering the latest news from the original Foresight VCT (FTV). They have announced a General Meeting on the 8th March to consider two matters:
- An offer to investors to raise up to £20 million by an issue of new shares (an offer document was enclosed with the notice to existing investors).
- The introduction of a new performance fee for the Manager (Foresight Group) and co-investment scheme.
As regards the former, the covering letter from the Chairman suggests that the VCT is “regarded as one of the best performing VCTs” and has “20 years of market leading performance”. That’s not my experience having held this VCT for almost 20 years. Just looking at the latest AIC figures for the company it shows an NAV Total Return of minus 4.9% over 5 years and minus 7.1% over 10 years. That compares with a comparative sector performance of generalist VCTs of plus 50% over 5 years and plus 73.6% over 10 years at the time of writing.
Foresight VCT did achieve one very good realisation in its early years which had a major influence on their reported performance subsequently. This was Yoomedia – it later transpired that they floated on AIM on the basis of fraudulent accounts.
In respect of the new performance fee arrangements (there is no existing one following the merger in 2015), this looks a particularly egregious one. I am not in favour of management performance fees (on top of the normal fixed percentage base fee), for any investment trust. But this one looks both easy to achieve and can result in perverse payments.
The proposed performance fee has two hurdles that both have to be achieved for a payout to be made. The first (Hurdle A) requires an NAV Total Return of 100p over 3 years, from a base of 88p. In other words a total return (capital plus dividends paid) of 13.6% over 3 years which is roughly equivalent to 4.5% per year. Hardly a great return is it?
In addition as it is partly based on dividends paid out it is open to manipulation as we have seen with other VCTs who paid performance fees based on dividends in the past.
The second hurdle (Hurdle B) pays out on individual investments which achieve a return of 4% plus RPI per annum (say 6% at present). Any companies exceeding that on a full or partial realisation cause a payment to be made of 20% of profits to the Manager.
Now the returns on individual investments within VCTs vary widely. Some will show losses, while others can produce returns of 5 times, ten times or even more from the initial cost. But this formula ignores the losses (so long as Hurdle A is met) so in practice large fees can be paid out on a few successful investments when the overall return on all investments is very pedestrian. It also means losses in one year can be ignored, while large profits are paid out in good years if there are just a few successful investments.
Paying out based on individual investments is not right – it encourages a search for lottery tickets. Shareholders only get a return based on the whole portfolio, so the manager shouldn’t be able to cherry pick returns out of that.
This is not a wise performance incentive arrangement even if the principle of even having one was accepted.
Shareholders are recommended to vote against the proposed performance fee arrangement.
Roger Lawson
This was the response to the blog note by John Gregory, Chairman of Foresight VCT:
Dear Roger,
Your recent message enclosing a draft of your report on our proposed Incentive Fee Arrangement has been passed to me and I hope I may be able to offer some background and clarification in order to demonstrate why the Board believes the co-investment and incentive arrangements should act together in the best interests of shareholders:
• The investment management team at Foresight Group who manage our investments have wanted for some time to have the opportunity to invest personally alongside the VCT in qualifying investments. The co-investment agreement enables them to do this in all future deals on a consistent basis; the Board of the VCT see this as a positive benefit because it closely aligns the interests of both shareholders and those responsible for sourcing, negotiating and managing investments.
• The incentive agreement is again designed to provide potential reward to those individuals most closely associated with creating successful investments and like the co-investment agreement it will only relate to new investments, it will not apply to any of the 27 existing investments.
• In considering the incentive arrangements, despite the fact that they would only apply to new investments, the Board and the fund management team at Foresight appreciated that it would be appropriate for there to be a clear and ongoing demonstration of the positive performance of the existing investments before any potential rewards became payable in respect of incentive arrangement for new investments. The initial hurdle in the proposed agreement requires significant growth in the NAV of the whole fund before any co-investment payments might be made.
• Once the initial hurdle is achieved there are provisions in the proposed incentive agreement which require maintenance of this performance, including upward adjustment for any successful realisations and co-investment payments, on an ongoing basis.
• Further protection against ‘premature’ payments under the proposed incentive arrangements is contained in the inclusion of a minimum three year delay from a performance incentive being achieved to being paid, this three year period only commences when the whole fund initial hurdle has been achieved and provides for an ongoing three year ‘look back’.
• In addition to the initial hurdle, a second hurdle is proposed in respect of individual investment performance and the two hurdles are designed to work together to ensure above average investment performance and avoid instances of payments being made in respect of individual successful investments at times when other less successful investments might be acting to the overall detriment of the fund.
• Over the past 5 or 6 years the Board and the fund management team at Foresight have jointly been repositioning the VCT in the anticipation of securing significant success in the future. The Board believes that the proposed incentive arrangements will enhance this success by retaining and suitably incentivising the key members of the investment team.
The Board is aware that there are conflicting views surrounding the effectiveness of performance incentive schemes in general, however, they have become ‘standard’ in the majority of successful VCTs. In proposing this scheme, which includes the double hurdle in addition to the minimum three year ‘look back’, the Board believes that it makes this one of the most demanding schemes in the sector and properly protects the interests of shareholders.
I hope that the above is helpful to you in your evaluation of our proposals, please don’t hesitate to ask if there is anything further which I can provide to help you.
Kind regards,
John Gregory
Chairman
Foresight VCT plc
In reply to John Gregory:
1. None of that reply addresses the fundamental issue that investors expect a baseline hurdle that rises each year to tie it to a return to us. A performance incentive on a mediocre or even negative overall return is not reasonable. Your scheme is guaranteed to bring that about from time to time (possibly even most years) unless performance is so abysmal that the initial hurdle is never met!
2. (a general comment) Any VCT bonus should be paid entirely in shares, with a five year lock-in to match investors’ experience on subscription.
3. If team members wish to co-invest, they can buy shares in the VCT. This would be entirely welcome: an alignment of interests in a transparent manner. To do otherwise raises questions of why: are they getting more favourable terms than shareholders? Are their interests properly aligned with shareholders? To invest otherwise adds complexity, reduces transparency, and raises at least a suspicion of conflict of interests.
I’m aware that there are some ugly incentive schemes elsewhere in the industry: for example, Octopus Titan have recently taken a large incentive payment on a rather mediocre annual return to shareholders. But at least Titan has achieved much better medium-term returns, and their scheme (though ugly) won’t pay out on a negative return.
If you are asking for a new scheme, you should at the very least model it on industry best practice, such as Baronsmead’s incentive schemes. Don’t insult us with this horror.
Do Foresight consider their VCT investors to be fools?
This proposed performance fee is an utter disgrace. If it is approved I shall sell all of the various Foresight VCT shares I have held for more than 5 years and the remainder as the 5 year anniversaries become due. I shall certainly not be taking up any future VCT offers from Foresight.
In reply to John Gregory
I want a board of directors who will challenge costs (albeit described as incentives) that have become “standard” !!
Is cost reduction a standard agenda item on Board meetings, it is for successful companies
Did the directors devise the principles of this scheme or did it come from Foresight?
In my experience of both setting and receiving management incentives, most (all?) come with perverse incentives, the more complicated they are the more likely it is that perverse incentives will occur
If you honestly believe that an incentive works keep it simple, speaking for myself I would look for 6% compounded total share price return from launch ( excluding tax refund on new shares) + cumulative 4% of NAV dividend payments as hurdles, incentive paid in shares that have to be held for five years.
The only time that incentives should be reset is on change of manager or unless there has been a totally unpredictable major external change
I will sell Foresight VCT if this is approved
i can’t see any resolution about the incentive offer- please clarify where and how we are supposed to vote on this?
If you are on the share register, you should have received the notice of the meeting and voting form by post. If you are in a nominee account, a copy of the notice is probably on the Foresight VCT web site (or can be obtained from them), but you would need to instruct your nominee operator to vote the shares in that case.
Ali, the resolutions (including that for the incentive scheme, which is resolution 4) are set out in this circular: http://www.foresightgroup.eu/user_uploads/np0117-2294_circular_p03b_cln.pdf , if you have not received a paper copy. The scheme is described in the earlier part of the circular and the notice of meeting is on pp15-16.
Best, Mark
Hi
yes foresight drew my attention to it and it’s an oversight on my part – just as well that i checked as i ticked the resolution but changed to against when i realised
many thanks