Don’t Expect Follow On Offerings From Sprott Any Time Soon (PHYS, PSLV)

One of the main problems with the closed end trust structure (as opposed to the ETF structure) revolves around secondary offerings.   While ETFs allow authorized participants to bring assets to their Trust in exchange for newly issued shares (creation) or give shares back to the Trust in exchange for the underlying assets (redemption) – closed end funds require their Trust to go out and sell more units in order to raise money and then go out and purchase the underlying assets themselves.*

There are a few weaknesses with this structure:  the first is that the Trust often pays an underwriter hefty fees in order to place the newly issues shares in the market, and the second is that the Trust is exposed to execution risk: the price at which the bullion is actually purchased may display “slippage” costs compared to the money that was raised in the offering.

Most closed end funds have some “protection” clauses in their prospectuses to make sure that such offerings are not dilutive to NAV.  Sprott’s Physical Silver Trust ($PSLV: no positions), for example, has the clause** (page 15):

“The Trust may conduct further offerings of units from time to time. Under the provisions of the trust agreement, the net proceeds to the Trust of any offering must be above NAV at the time of the offering.”

Sprott’s Physical Gold Trust ($PHYS: no positions) has a slightly different wording (page 23): The Trust

“will not issue units following the completion of this offering except (i) if the net proceeds per unit to be received by the Trust are not less than 100% of the most recently calculated NAV prior to, or upon, the determination of the pricing of such issuance or (ii) by way of unit distribution in connection with an income distribution.”

So the net proceeds from any offering have to be greater than or equal to the most recent Net Asset Value of the Trust: that’s a good thing, of course, since no one likes offerings that are dilutive to NAV.   The problem is that the Trust pays underwriters a hefty fee – more than 4% – to do the offering.   Additionally, the offerings are usually done below the most recent trading price of the Trust, to entice new buyers.   Put these two factors together and what to you get?  You need the Trust units to be trading at a premium to Net Asset Value of well more than 4% in order to do a non-dilutive offering, and in order to avoid violating the terms of the prospectus.

PSLV’s prospectus notes:

pslv_prospectus

The trading price being above NAV isn’t nearly enough, though – as I explained above.  The trading price of the Units has to be at enough of a premium to provide “cushion” for both the discount to trading price for the offering, and the underwriter’s fee.

With current premiums languishing in the 1/2% – 2% range recently, secondary offerings for Sprott’s Physical Gold Trust and Physical Silver Trust cannot be implemented, and the Trusts cannot accumulate more metal.

disclosure: long $SPPP

-KD

* Some closed end funds, like Sprott’s Physical Bullion funds, do have a redemption mechanism where investors can exchange shares for bullion – but not vice versa: investors cannot create new shares by delivering bullion to the Trusts.

** Sprott’s Physical Platinum and Palladium Trust ($SPPP) has the same clause.

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