Description

First Opportunity Fund (FOFI, previously FF)

Big Picture:  Closed end fund trading at an approximate 30% discount to net asset value.  The top ten holdings as of 6/30/2011:

1.       Wolf Creek Partners LP            18.62%

2.       Bay Pond Partners LP               16.90%

3.       J. Caird Partners LP                    7.70%

4.       North River Partners LP            6.33%

5.       JPM Prime Money Market         6.17%

6.       First Republic Bank                     5.85%

7.       Johnson & Johnson                     2.37%

8.       Dreyfus Cash Mgmt                    1.87%

9.       Forethought Financial                1.85%

10.   Iguaza Partners LP                       1.80%

Total                      69.46%

As you can see, 51.35% of the assets are invested in five partnerships.  The partnerships are Hedge Funds sponsored by Wellington Hedge Management, an indirect wholly owned subsidiary of Wellington Management.  The remaining assets are invested primarily in financial stocks – legacy holdings from the fund’s prior existence.  You can see the entire list of holdings at the attached link:

http://www.firstopportunityfund.com/holdings.asp

The plan is to liquidate the legacy holdings over time (~two years) and reinvest the proceeds.  The proceeds from the legacy holdings sales will most likely be re-invested in Berkshire Hathaway, Johnson & Johnson, Wal-Mart, etc. given the investing philosophy (more discussion below) of the new co-advisers.  FOFI provides the only opportunity I have found for non-qualified investors to invest in hedge funds through a publicly traded security.  Further, the opportunity exists at a significant discount to NAV.  I am familiar with the Wellington Hedge Funds and it is my understanding that they have experienced superior long-term risk-adjusted returns.   The story is a bit more complicated than an undervalued closed-end fund but it is at least a great place to start.

Brief History

The fund (initially called First Financial Fund and traded on the NYSE under the ticker FF) was founded in 1986 and was managed by Nick Adams, a partner at Wellington Management, from inception through March 2010.  Over this period the fund was required to have at least 65% of its assets invested in financials.  I understand the information is dated (June 13, 2005), but in the attached article Nick is mentioned as having managed the best performing hedge fund “of this decade”:

http://money.cnn.com/magazines/fortune/fortune_archive/2005/06/13/8262560/index.htm

Bay Pond is the same hedge fund that is now the #2 holding of FOFI.  From 1988 through year end 2009, under Nick’s guidance, FF’s NAV compounded at 13.4% while the S&P 500 compounded at 5.4%.  I did not include re-invested dividends or taxes, but it is safe to conclude that Nick significantly outperformed the market over 20 years as manager of FF.  By the way, I started with 1988 because that was the first year Bloomberg reported an NAV for the fund.

Although the fund performed well over a long period, it did suffer significantly in 2007 and 2008, declining 20% and 57%, respectively.  In the March 2010 Proxy Statement, the Board proposed significant changes to the fund.  The following is taken directly from the Proxy Statement:

“Since the Fund’s inception in 1986, Wellington Management Company, LLP (“Wellington Management”) has served as the Fund’s investment adviser.  During this time, the Board believes that the Fund has delivered a strong track record of performance relative to its peer groups and the relevant indices.  At past meetings, members of the Board have discussed various ways of increasing the potential future returns of the Fund including investing in hedge funds.  As a consequence of these discussions, ultimately the Board concluded that stockholder value could be enhanced by investing a significant portion of the Fund’s assets in hedge funds, in particular, some hedge  funds sponsored by Wellington Hedge Management, LLC (“WHM”) (an indirect wholly owned subsidiary of Wellington Management) and advised by Wellington Management (the “WHM Hedge Funds”).  In order to accommodate investing in any WHM Hedge Fund, the Fund must change its investment adviser to an entity or entities that are not affiliated with the current investment adviser, Wellington Management.”

Ultimately the proposal was approved.  What did it mean?  1) FF would now invest in hedge funds, 2) FF would no longer hold at least 65% of its assets directly in financials and 3) Wellington could no longer be the advisor.  In connection with the approved proposal, the NYSE suspended trading (de-listed) in FF.  As the fund stated in a press release announcing the approval of the proposal, “the NYSE does not have a listing standard expressly prohibiting or otherwise regulating the Fund’s ability to invest in hedge funds.  The NYSE has indicated that it will exercise its discretionary authority under the NYSE rules and initiate its de-listing process based on it being in the ‘public interest’.”  Wow.  Clear as mud but the net effect is that FF would now trade under the symbol FOFI and trade OTC/Pink Sheets.  Wellington could not be the advisor AND invest in Hedge Funds run by an affiliate.   Therefore, Rocky Mountain Advisers and Stewart Investment Advisors would serve as the fund’s co-advisers.  Who are Rocky Mountain Advisers and Stewart Investment Advisors?  Entities owned/controlled by Stewart Horejsi.

Stewart Horejsi

Stewart Horejsi is a Berkshire millionaire.  He ran a family owned welding company for a number of years and as margins in the business declined instead of re-investing in the business he purchased Berkshire Hathaway stock.  He bought his first slug of 40 shares for $265.  The following link provides some background information on Horejsi:

http://www.bizjournals.com/phoenix/stories/2008/11/17/story23.html

Following the sale of the welding company Stewart has focused the majority of his time investing.  One of Horejsi’s strategies is buying closed end funds at a discount to NAV, taking over the board, and inserting a family owned entity as adviser.  Take a look at BIF and BTF if you have the time.  Boulder Investment Advisers and Stewart Investment Advisers (Horejsi affiliated entities) are the co-advisers and they employ Stewart Horejsi as the portfolio manager for both funds.  The top holding in each of the two closed end funds is Berkshire Hathaway – 25% in BIF and 36% in BTF.  The Horejsi family (directly and through various trusts) owns ~35% - 40% of each of the funds.  There are additional examples, but you get the picture.  Buy controlling interests in closed-end funds at a discount, insert your own board, assign your own adviser, earn fees and own high quality assets at a discount.  As adviser, you don’t really care about performance (discount relative to NAV) and therefore your shareholders because you are earning a fee on assets.  One would expect a shareholder driven closed end fund would repurchase shares in the fund when the discount gets >10%.

It appears that Stewart Horejsi began acquiring shares of FF in the late 1990’s/early 2000s.  I reviewed annual proxy statements as far back as sec.gov would go and Stewart Horejsi and family trusts began appearing in the shareholder tables in the early 2000s.  In 2003 Joel Looney became the Chairman of the Board – he is also on the Board of other Horejsi owned and managed closed end funds.   The “Independent” Directors of FOFI are currently Joel Looney, Dean Jacobson and Richard Barr.  Each of the three is also a Director of the previously mentioned Boulder Funds – BIF and BTF.  The “Interested” Directors of FOFI are Susan Ciciora and John Horejsi – Stewart Horejsi’s children.  According to the 2011 Proxy Statement 36.43% of FOFI shares are owned by Horejsi Associates, including Stewart R. Horejsi Trust, Lola Brown Trust, Mildred B. Horejsi Trust and Susan L. Ciciora Trust.

Through the actions of Stewart Horejsi and his associates one of the most successful NYSE listed closed end funds of the 1990’s-2000’s has been converted to an OTC/Pink Sheet traded closed end fund that invests in hedge funds.  One of the hedge funds being managed by the former manager of the extremely successful FF.  Stewart Horejsi now earns a management fee through the two advisory companies and, primarily due to the lack of clear information about the fund and the fact that it is traded OTC/Pink Sheets, is able to buy interests in very successful hedge funds at significant discounts to NAV.  The Mildred B. Horejsi Trust  buys shares on a weekly basis.

Conclusion

Ultimately Stewart Horejsi created a structure that allows him to take interests in very successful Wellington Hedge Funds at a significant discount to NAV.   Imagine an FF holder meeting with his/her financial adviser following the conversion.  Would the adviser ever suggest keeping the security?  Suspended dividend, de-listed from the NYSE and very little to no disclosure about 50%+ of the assets.  This drives a cheaper price/bigger discount with no constituency other than the family most knowledgeable about the investments. 

The story is not without risks and I cannot foresee a clear catalyst closing the discount.  However in an environment where long term investors favor gold over stocks 5:1 I love the opportunity to buy an investment in Wellington Hedge Funds at $0.70 on the $1.00.  I fully understand the Horejsi angle, but am comfortable given the amount of the discount and the fact that Horejsi is buying the stock.  This situation also seems different from the more “traditional” Horejsi strategy because this seems more about setting up a structure that allows him to buy assets at a discount compared to setting up a structure to earn fees.  Yes, there is that component to the story but it doesn’t appear to be the primary driver given he is buying stock hand over fist.  I understand not a traditional idea but one that should provide significant value creation over time.

Catalyst

Improvement in financials (I know, I know) - legacy assets and at least Bay Pond are focused on financials

Recognition of the story