A Listed Investment Company (LIC) manager recently told me that investing in LICs was a “no-brainer”. Sell those trading at a premium to their net asset backing and buy those trading at a discount. If only it were that simple.
I have watched many LICs over the years trade at seemingly permanent discounts to their asset backing, frustrating their managers and shareholders. It means the LIC is worth less than the market value of investments in its underlying fund.
I have also seen LICs trade at hefty premiums for longer than most expected. Investors paid more for the LIC than its assets were worth because they rated the manager and expected continued strong performance. The LIC’s asset value kept rising and so did its share price.
To recap, LICs are essentially listed managed funds that trade on the ASX. Unlike unlisted unit trusts, LICs have a fixed pool of capital (that can be increased if the manager raises capital). The fund’s size is not influenced by fund flows and market movements, meaning the LIC manager does not have to manage according to fund inflows and outflows.
LIC managers say this is a big advantage. It means they do not have to buy expensive stocks when fund inflow is strong, or sell cheap stocks to meet fund redemptions in bear markets. It should mean greater dividend and franking credit certainty compared with unit trusts.
High, fully franked LIC dividends partly explain why they have become popular with self-managed superannuation funds (SMSFs). Lower annual management fees (compared with unit trusts and even some exchange-traded products) and the preference of many SMSF and self-directed investors to invest in listed entities are other factors.
However, LIC critics say the structure favours underperforming managers who keep all their fees regardless of performance (although poorly performed LICs inevitably get taken over). Also, too many LICs trade at a discount to the value of their assets.
Cynics argue that the latest LIC IPO boom is more about fund managers, who were better known for unit trusts than listed investments, looking to cash in on rising LIC hype and “gather assets”. Their poor collective performance since listing had made it harder for other LIC IPOs.
Watch the premiums and discounts
For all the complications, LIC discounts and premiums are valuable information if used correctly. Rather than view them in isolation, look at a LIC’s five-year average premium or discount and compare it with the current figure (easily accessible through the handy ASX/Morningstar monthly listed managed funds reports).
LIC premiums and discounts have a tendency to revert to their mean over longer periods. So a LIC trading at a premium that is well above its long-term average has a higher chance of premium compression, and one trading at a larger-than-usual discount is worth following.
However, that strategy is not much help with a batch of larger LICs that have listed on ASX in the past two years. They do not have much trading history, so investors have to form a view on the appropriateness of the premium or discount in isolation.
I have followed the LIC Initial Public Offerings reasonably closely, partly because I had foreshadowed a coming boom in the LIC market two years ago and because some of the new LICs were launched by several of the market’s most prominent investors. They include Platinum Asset Management, PM Capital, Ellerston Capital, Perpetual and Argo.
Most of these high-profile LICs are trading at a discount to their asset backing. The Ellerston Asian Investments LIC, for example, traded at a 9.3% discount to its pre-tax Net Tangible Assets (NTA) in March 2016, ASX data shows.
The Perpetual Equity Investment Company traded at an 8.5% discount, the Argo Global Listed Infrastructure Fund traded at a 7% discount, and the PM Capital Global Opportunities Fund traded at a 16% discount.
To put that in perspective, investors could buy a dollar of assets in the PM Capital Global Opportunities Fund for 84 cents, through a LIC managed by PM Capital, one of most consistent outperformers in global equities.
However, care is needed with raw figures on LIC discounts/premiums. Option issues that accompany most LIC IPOs, and potentially lead to greater share issuance, can distort the real figure and are not considered in most published premium/discount data.
IPOs, by their nature, distort LIC premiums/discounts because the offer’s considerable costs come out of the asset backing. A dollar raised might only mean 97 cents is available to be invested after all IPO fees are paid, so the LIC immediately trades at a discount.
Moreover, the discount/premium varies depending on whether one looks at pre-tax or post-tax NTA (I prefer pre-tax).
And the LIC could trade at a large, sustained discount to its NTA, if the manager has a record of underperformance, the dividend record is patchy, or the market is concerned about the LIC’s underlying investment class (emerging-market equities, for example), or their liquidity (with micro-cap stocks).
Caveats aside, here are four newer LICs worth watching at current prices:
1. Bailador Technology Investments
Co-led by former Fairfax Media CEO and All Blacks rugby captain David Kirk, Bailador (BTI) is one of the market’s more interesting LICs. It is the only one to focus exclusively on privately-owned technology companies in the growth phase – a market that is traditionally the preserve of venture capital/private equity funds and hard for retail investors to access.
I rate Bailador’s management, strategy and record in technology investing. It raised $24 million in a November 2014 IPO and its share price has finally edged past the $1 issue price, despite good asset revaluations and a pre-tax NTA in April of $1.16.
As a new LIC, Bailador deserves some discount, but 10% is a touch excessive.
Chart 1: Bailador
[1]Source: Yahoo!7 Finance, 2016
2. Argo Global Listed Infrastructure Fund
Argo is one of the market’s best-known and largest LIC managers through the $4.9 billion Argo Investment LIC. It raised $286 million for the global LIC (ALI) and listed on ASX in July 2015 through an IPO. Its $2 issued shares trade at $1.79 at a decent discount to NTA.
It’s hard to go past Argo as a LIC manager (even though it outsources stock-picking in the global fund to an infrastructure specialist) and I like the long-term outlook for global infrastructure equities and fixed-income securities.
Management fees are a touch high at 1.2%, but global infrastructure has a useful role in portfolios, as does using a well-regarded manager to invest through a fund approach.
Chart 2: Argo Global Listed Infrastructure
[2]Source: Yahoo!7 Finance, 2016
3. PM Capital Asian Opportunities Fund
The PM Capital Asian Opportunities Fund (PAF) listed on the ASX via an Initial Public Offering, raising $55 million through the issue of $1 shares. They fell to 84 cents, before recovering to 92 cents – a big discount to the latest NTA of $1.08.
Asian equities are trading near historic valuation lows and PM Capital has a good record in this region. The price-to-book ratio for the MSCI Asia (ex-Japan) index, a favoured valuation metric, was 1.3 in March – low by historic standards.
Eagle-eyed investors could spot a double discount of sorts in the PM Capital Asian Opportunities Fund: a LIC trading at a discount to its underlying Asian equities, which in turn are trading at a discount to their long-term valuation averages.
The LIC is worth a look for long-term investors, who want exposure to Asian equities (ex-Japan) and understand the risks of investing in the region.
Chart 3: PM Capital Asian Opportunities Fund
[3]Source: Yahoo!7 Finance, 2016
4. Ellerston Global Investments
Launched in late 2014 through a $75 million IPO, the LIC (EGI) was one of several global equity funds that listed on the ASX when the Australian dollar was just below parity with the US dollar and increasing exposure to global equities was an obvious strategy.
The Ellerston Global LIC is trading at 91 cents, well below the $1 issue price and latest pre-tax NTA of $1.09. Since inception in November 2014, the Ellerston Global Investments portfolio has returned 14.81%– well ahead of the 2.15% return in its benchmark MSCI World Index. The NTA discount in the global LIC will have to narrow if Ellerston maintains that outperformance.
The LIC is 80% invested in US equities and hedged for currency exposure. It looks a cheaper way to gain exposure to US equities at a discount, but as a $69 million LIC, it suits investors comfortable with micro-cap companies.
Chart 4: Ellerston Global Investments
[4]Source: Yahoo!7 Finance, 2016
– Tony Featherstone is a former managing editor of BRW and Shares magazines. This column does not imply any stock recommendations or offer financial advice. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at April 20, 2016.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.