Investors are perennially warned against buying stocks listed on the so-called Pink Sheets, often referred to as the "Wild West" of markets. Some observers may therefore be surprised to learn that some top-rated mining and metals funds have holdings of stocks in companies that are not listed in the U.S. other than on the Pink Sheets.
Vanguard Precious Metals and Mining fund, the only specialty precious-metals fund to receive five stars from Morningstar, provides an eye-popping example. Its top-three holdings are Pink Sheet stocks,
, accounting for 9%, 7% and 6%, respectively, of the overall portfolio as of June 30, the latest data available.
It's not as if Vanguard's alone, As of Sept. 30,
Evergreen Precious Metals holds shares of Pink Sheet names, notably
(6.4% of its portfolio), Lonmin (2.1%) and Impala Platinum (2%). Other well-known funds doing similarly include the
Franklin Gold and Precious-Metals fund and
Fidelity Select Gold fund.
So what gives? Are these funds holding toxic waste? Or are professional money managers exempt from such advice?
The explanation appears to be a function of a geographically diverse industry. When picking mining stocks, confining the search to the U.S. just doesn't cut it. That's because the universe of stocks in terms of size and number is greater abroad.
is by far the best known U.S. company, and it is a great company. But most of the great companies in the space are international companies," says Joe Wickwire, portfolio manager for Evergreen's precious-metals fund. "We are looking to put together the best possible diversified precious-metals portfolio we can," and that includes going global.
A U.S.-only focus would exclude
, headquartered in Toronto;
, based in Johannesburg; and
from Vancouver. Those three foreign miners trade on major U.S. exchanges, some other stellar stocks do not.
That important subset includes Impala, AngloPlats and Lonmin. All are Pink Sheet residents, but none of them are fly-by-night operators. The three boast billion dollar plus revenues and all mine platinum, a metal that looks set to benefit from the increasing use of pollution-busting catalytic converters. Melbourne-based Newcrest is a world-class gold and copper miner with sales of around $1 billion.
So what about the warnings? The two major drawbacks of pink listings are the
lack of disclosure and low liquidity.
Stocks that do not meet
standards can be traded on another part of the over-the-counter market, colloquially called the "Pink Sheets." In the past, prices for such stocks were printed on pink paper, and the name stuck.
"Pink Sheet listings have virtually no requirements for listing and no financial disclosure requirement," says Marc Lipson, professor of finance at the Darden School of Business in Virginia, who also serves on the Nasdaq academic advisory board. In this case, however, he's not too worried.
"It raises no red flags for me in this case because the companies are listed elsewhere," he adds.
Lonmin, AngloPlats and Impala trade on the London Stock Exchange, which has quite stringent listing standards. And Newcrest is listed on the Australian Stock Exchange, another reputable bourse.
Or put another way, because these companies disclose financial information to list elsewhere, stockholders can get the information needed for sound investing. Beware, however, because not all pink-listed firms do so.
Foreign listings also partially take care of liquidity concerns.
"We need markets, whether U.S. or global, to be large enough to get out of the entire position in one day," says Clay Hoes portfolio manager of the Riversource
Precious Metals, which holds shares of Lonmin.
Frequently that means trading on local markets, but not always. "It's important to distinguish between those that have their primary listing on the Pink Sheets and ADRs," says Steve Land, portfolio manager at Franklin. ADRs, or American Depositary Receipts, are certificates or receipts for foreign shares and can be bought and sold like other stocks on the Pink Sheets or the major exchanges. Land gets more concerned when the stock is primarily Pink Sheet listed.
ADRs can be created or reversed for 5 cents, Land says. And sometimes that provides arbitrage opportunities when prices in two markets are sufficiently divergent. Again, that may be logistically unfeasible for small investors, but not for those with substantial means and sophistication.
Darden's Lipson also notes that the lack of a full listing in the U.S. may be reflective of the changing world. In the past, he notes, firms couldn't raise the capital in local markets, so they had to get a U.S. listing. That's now changed.
"If you can access all the capital you need by going to London or Toronto, then what are your benefits of adding a U.S. listing," asks Lipson. He doesn't see Sarbanes Oxley as a major impediment to listing, but others may.
So should small investors feel safe buying such Pink Sheet holdings directly? Probably not.
"This universe that we are talking about is an inefficient universe. If you are not an expert in this area, you should probably leave it to professionals," says Evergreen's Wickwire. "It has enormous volatility."
At the time of publication, Constable was long USAGX and FSAGX, although holdings can change at any time.