Published by Closed-End Fund Advisors, Inc.
George Cole Scott, Editor
Ellsworth Convertible Growth and Income Fund
Bancroft Convertible Fund
The twin funds are managed by Davis-Dinsmore Management Company, founded in 1971 and is a privately held registered investment advisor specializing in convertible securities. Assets under management include two publicly held closed-end mutual funds, the Bancroft Convertible Fund (BCV) and the Ellsworth Convertible Growth and Income Fund (ECF).
Davis-Dinsmore is included in Nelson’s World’s Best Money Managers listing for three years and five years ended March 1999. Ellsworth earned two Performance Achievement Certificates from Lipper, Inc., for the five years ended December 31, 2002, outperforming other closed-end convertible funds. Bancroft also received certificates for the one year and five years ended December 31, 1997. [Lipper, Inc. is a globally recognized organization that ranks the performance of mutual funds.]
As of September 30, 2003 the major industry exposure of Ellsworth Convertible was as follows:
Performance as of September 30, 2003
|1 Year||5 Years||10 Years|
|Ellsworth Net Asset Value||14.02%||33.88%||133.72%|
|Closed-End Convertible Fund Average||27.36%||42.09%||103.80%|
|Lehmann Aggregate Bond Total Return Index||5.41%||37.83%||95.26%|
|% of Net Assets|
|Financial and Insurance||10.9%|
|Banking/Savings and Loan||9.7%|
|Aerospace and Defense||5.3%|
|Cash and Equivalents||2.7%|
Ellsworth Convertible Growth and Income Fund (ECF-AMEX) announced the completion of its recent rights offering, which expired on November 19, 2003. The Fund’s shareholders have subscribed, either through the primary subscription or the over-subscription privilege, for all 1,754,826 shares of common stock available in the rights offering at a final subscription price of $7.53 per share. This is 95% of the volume-weighted average sales price of a share of the Fund’s common stock on the American Stock Exchange on November 20, 2003 and the four preceding trading days. All shares issued in the rights offering are newly issued shares.
We interviewed Tom Dinsmore, Chairman of Ellsworth Convertible Growth and Income Fund and Bancroft Convertible Fund, on November 25, 2003.
Scott: How are you, Tom?
Dinsmore: I have been as busy as a one-arm paperhanger, with the rights offering and everything else going on.
Scott: Oh, they work harder than you do?
Dinsmore: [Laugh] I have been working as hard as they do.
Scott: We find that many investors still don’t understand convertibles. Would you explain what they are to further understanding?
Dinsmore: Very long run performance numbers show that convertibles outperform common stocks. You have to hold onto them for a long time. Convertibles are not representative of the stock market, but tend to be more speculative issues. Over five and ten years, performance is better than the S&P 500. The CS First Boston Index is well below the S&P 500 Index because the index contains a lot of speculative companies. There are convertible bonds and convertible stocks; both are convertible into common stocks, usually into the issuing companies, but not always. In convertible bonds, you either have a maturity date or a “put” date that gives a certain amount of stability to it as long as the balance sheet is secure. If there is a “put” date, this is the date when you can “put” the bond to the shareholder.
Scott: Yes, I also have been working overtime on your Ellsworth rights offering which is a lot of work for money managers. I notice you priced it about 3% below your expected price of $7.76 at $7.56.Would you tell us how the rights offerings for Ellsworth and Bancroft benefits your shareholders?
Dinsmore: We have been working hard to reduce our expense ratio closer to 1%. We have looked at many things with the investment management company’s breakpoint at $100 million. We managed to drop it from 75 basis points (3/4% of one percent) to 50 basis points as we now have over $100 million dollars in the Ellsworth fund.
Scott: What is the portfolio turnover rate?
Dinsmore: Turnover for a convertible fund is problematical because convertibles get called all the time. They get converted as the issuer can force it. In a very volatile market, bonds are frequently converted. If the premium is too big, you can sell the bond. So, your turnover rate may be higher than your investment perspective.
Scott: How has your performance held up this year?
Dinsmore: When you compare us now to the total thirteen convertible funds, versus eight a year ago, we have found that, in the present Bull Market, six funds in our peer group use leverage and eight of the thirteen that have more than a third of the funds in high yield convertible debt, high yield junk bonds. Out of that eight, more than 50% have over half of their assets in high yield debt and another two have almost 50% in junk bonds. So, if you had a lot of junk bonds in your portfolio over the last year, you were a very happy man. Between leverage and junk bonds there were only four closed-end convertible funds that were unleveraged convertible plays.
Scott: Tell us more about how leverage is used in convertible funds?
Dinsmore: Moody’s just published a report on closed-end funds and the use of leverage. It may be found soon on the Closed-End Fund Association web site (www.closed-endfunds.com/). The report lists seven non-leveraged convertible securities funds, of which Bancroft and Ellsworth are two of them. There are also six leveraged convertible funds listed. The leveraged funds usually outperform in markets where there is declining interest rates, but have a difficult time in periods of rising interest.
Scott: Do you always use convertible preferreds?
Dinsmore: Yes, absolutely: they can add a lot of value over the years, but there will be periods of time when they are not attractive. Over the last year or so, convertible preferreds have held up very well. They are not particularly attractive as a group right now.
Scott: In the rights offering, you talked about dilution because of the issuance of new shares. How did it come out?
Dinsmore: Since we had to sell it at $7.53, the dilution came to just over 2% which I am not that happy about as I was hoping to keep it at 1%. If we had done the $7.76 number we estimated, the dilution would have been around 1%.
Scott: True, but the shareholders got a good value. And it is now trading near $8.00 a share. We subscribed to as many shares as we could in the after-market as well and got all we wanted, a good thing for our clients. What are the other benefits?
Dinsmore: Increased liquidity. Particularly with Bancroft in our earlier rights offering this was true. Brokers complain that the fund is too illiquid, and we see the rights offering giving a significant boost in liquidity. Before the rights offering, Ellsworth had an average daily volume of 15,000 shares. In the past 30 days, it has been over 51,000. The average daily volume for Bancroft was under 5000 prior to the rights offering; it has increased to 10,000 in the last 30 days. There was a fair amount of arbitrage in that, however. We will see how it works out down the road. Studies have shown that rights offerings have added significantly to the liquidity in the stock. I also thought that the offer itself was very attractive, and it will increase broker interest. Another benefit of the rights offering is that by now having the fund’s assets over $100 million, it qualifies as a Qualified Institutional Buyer (QIB). Only QIB’s can purchase rule 144a security offerings and the majority of new convertible issues are now issued under this rule.
Scott: What is the breakdown between bonds and preferred stock in your two funds?
Dinsmore: For Bancroft, we have 57% in bonds, 21% in convertible preferreds and 19% in mandatory preferred, which are usually a preferred, but can also be a bond. When you purchase it, you know that on a certain date it will be converted. You know the conversion price no matter what the common stock price happens to be. Because the bond nearly always has a higher yield than the stock, in reality, it is a dividend-enhanced common stock. In my opinion, convertible bonds are a very attractive alternative to common stocks when people want income. The problem is that not all of them give a dividend that meets the 15% tax requirements under the new tax bill. In tax-advantaged accounts it makes no difference. In a taxable account, you have to be very careful. In a convertible account, you give up some of the upside where you only get about 80%.
Scott: We love to use them in tax-advantaged accounts for our clients. Are you likely to go into the lower quality issues with convertibles?
Dinsmore: In 1986, roughly 10% of the common stock market issues had a convertible that you could buy rather than the stock. That is a very broad exposure of the stock market. In the late 1990s, the percentage of issues that had convertibles outstanding was something like 1.5% making it very difficult to put together a portfolio using modern portfolio theory. Or you could use a value portfolio to put together a decent portfolio in either of those categories. Today, we use 2.5% or 3% convertibles. While it is still difficult to create a broadly diversified portfolio that meet the standards for modern portfolio theory as applied to value investing, you can do a better job. The growth area is still far better represented than the value area in the convertible market. The more speculative issues are better represented than the more stable big-cap names, but you can put together a portfolio now that has some portion of that portfolio in speculative names.
Scott: What are the differences between Bancroft and Ellsworth convertible funds?
Dinsmore: The primary difference is that Bancroft must buy only convertibles, which are convertible into U.S. domestic stocks or into listed ADRs. Ellsworth has more flexibility where we can buy common stock up to 15% of the portfolio. It doesn’t happen often, but sometimes the common stocks are more attractive than the convertibles. So, we put the common stocks into Ellsworth and the convertibles into Bancroft. That is the major difference.
Scott: What about the scandals in the mutual fund industry? How does this affect the closed-end fund industry?
Dinsmore: Anything that affects the mutual fund industry as whole in a negative way affects people’s approach towards buying any mutual fund. This is true even if they are not affected by the practices that allowed people to hurt shareholder value. Whenever the marketing people run a firm you are going to get business, even if it is not 100% what you call desirable business.
We are affected in two ways, first, even though we can’t do after market trading which is a positive for us; on the other hand when you have a crisis of confidence that affects the assets of the people who are running these funds--all funds--that is going to have a negative affect on everybody even if we don’t deserve it. There are going to be some people who are going to say, “I am just going to put my money in the bank” and forget the stock market.
Scott: That’s interesting. We have found that many of the new clients who recently have joined us at Closed-End Fund Advisors recently are holding a large portion of their assets in cash for the reasons you mention.
Dinsmore: Yes, there are a lot of people who, when the market got crazy in the bubble, were smart enough to put their money into cash and never invested it. They now see that the market is perking up again and they say, “I bet it is safe to invest now”.
Scott: We also have run into some people who have been with other managers and feel ignored by them. We capitalize on this as we specialize in giving superior service to our clients who are interested in the conservative nature of closed-end funds. They then look at our web site and call or e-mail us for information about us.
Dinsmore: Regarding convertibles, they did get very expensive for a while. We can now get a breakdown of the average conversion premiums and what the average yields are, for instance. The average conversion premium of the issues followed by the Value Line Survey was over 100% from January to April of this year. It has since dropped to 41%. Now, the average conversion premium for preferreds is 100% or more so the convertible preferred market has gotten a lot more expensive. What is neat is that the premium over investment value is now 20%, a significant change from 50% a year ago. People say that the convertible market is overpriced when it has premiums over 50%, but if the premium over investment value has dropped from 50% to 20%, you have gotten something for it.
The problem is if you believe interest rates are going up from here, the premium over investment value isn’t as valuable as it would be if interest rates were going to go down. It makes it not as attractive from an equity buyer’s point of view as it used to be. Now, it has gone from grossly overvalued this spring to fairly valued now with lots of opportunities we didn’t have six months ago.
Scott: Keep up the good work and thank you very much.
The Investment Profession:
Getting Back to Responsibility And Ethics
Lately, the investment profession is finding its own good name a heavily discounted stock. Repeated scandals have highlighted the often too-cozy relationships of investment banks and their corporate clients and have battered investor confidence in analyst recommendations and in Wall Street’s integrity generally.
Yet this unfortunate state of affairs should not come as a surprise to informed people, those in the investment profession least of all. In a prescient 1994 Securities & Exchange Commission (SEC) report on personal trading by mutual fund manages, Barry Barbash wrote: “The industry will continue to be trusted by investors only if it demonstrates that it will maintain the highest possible ethical standards and that it operates free from abusive and fraudulent practices.” Many in the investment community have clearly not heeded his words
Many of life’s circumstances are created by three basic choices: the disciplines you choose to keep, the people you choose to be with, and the laws you choose to obey. — Charles Millhuff
Note: None of the information contained herein should be construed as an offer to buy or sell securities or as recommendations. Performance results shown should under no circumstances be construed as an indication of future performance. Data, while obtained from sources we believe is reliable, cannot be guaranteed.
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