The listed investment company (LIC) sector has been forced to fight back since the advent of exchange-traded funds (ETFs) that have eaten into its market. Some of the largest Australian LICs, such as Argo Investments (ARG) and Australian Foundation Investment Company (AFI) have taken their management costs down to 0.18% a year, to be competitive with the Australian equity ETFs.
LICs are still a larger sector than ETFs: at the end of May, there were 108 LICs trading on the Australian Securities Exchange (ASX), with a total market capitalisation of $39.9 billion, compared to 182 ETFs/ETPs (exchange-traded products), valued in total at $38.1 billion. But average daily value of trade is skewed heavily in favour of the ETFs, at $123 million compared to $25 million.
The LICs have a number of attributes that, for some investors, can be considered advantages over ETFs. Where an ETF must distribute all of its income each year, a LIC only distributes its income when its board declares a dividend. As LICs pay tax at the company tax rate, the distributions are usually fully franked dividends.
Because an ETF must distribute all of its income, the dividend amount can vary dramatically, being determined by the underlying index performance. In contrast, the LIC has flexibility in when and how much income it returns to investors, and thus can provide a steadier stream of dividends with less fluctuations.
LICs are also usually actively managed, and are trying to outperform their index benchmark or provide an absolute return to investors.
But the main difference is that because LICs are closed-end funds, the price is based on the price that investors are prepared to buy or sell the share for on any given day. As a result, the price of the share may trade at a large premium or discount to the net tangible asset (NTA) figure. This means that there can be opportunities to buy the portfolio for less than it is worth.
The share price of a LIC can differ from the NTA for a variety of reasons. A premium can exist if there is a lot of demand for the LIC: its historical performance could be strong, the long-term reputation of its management team could attract investors, its dividend stream could be higher than that of its competitors, its investment strategy or mandate could be temporarily more popular than that of other LICs. The level of fees could play a part, as could size, liquidity – low liquidity is a particularly pernicious problem for LICs – and prevailing market conditions.
The oldest and largest LICs – Argo Investments, AFIC and Milton Corporation – rarely trade at discounts. Premiums and discounts in LICs can exist for long periods – even years. Buying a LIC at a discount does not come with any guarantee that the discount will be removed any time soon, let alone that the stock could move to a premium. But buying at a discount can augment the investor’s long-term total return.
Here are my five best picks of LICs trading at a discount:
Carlton Investments (CIN, $32.30)
Five-year total return: 12.6% a year
Historical FY17 dividend yield: 3.7%, fully franked
Pre-tax NTA: $37.44
Discount: 13.7%
Operating expenses: 0.10%
The big point of difference with Carlton from other LICs is its very large holding in one company that is not one of the ASX’s largest – cinema, hotel and resort operator Event Hospitality and Entertainment Limited (EVT), the former Amalgamated Holdings. As at the end of March, the company’s holding in EVT, which was worth $428.8 million, represented 44.1% of the portfolio. That has been a good holding to own in recent years: in the last ten years, EVT has moved from $4 to the current price of $13.90. In the last five years, EVT has generated a total return of 16.7% a year.
In Australia and New Zealand, Event operates Event Cinemas, as well as Moonlight Cinemas across Australia Cinestar Cinemas in Germany, and it also owns the State Theatre in Sydney. The hospitality division operates the QT Hotels & Resorts, Rydges Hotels & Resorts and Atura Hotels brands, as well as the premier Australian ski resort township, Thredbo Alpine Resort. Analysts like the current outlook for EVT, with a consensus (Thomson Reuters) target price currently at $15.43, which is 11% above the share price, at $13.90. EVT is a bet on increased leisure spending and tourism, both of which are strong trends. Carlton Investments can be seen as a way to play this theme, while also participating in a diversified portfolio of Australian shares.
Whitefield (WHF, $4.46)
Five-year total return: 9.8% a year
Historical FY18 (March 2018) dividend yield: 3.9%, fully franked
Pre-tax NTA: $4.84
Discount: 7.8%
Operating expenses: 0.4%
Whitefield is one of the oldest listed investment companies (LICs) on the ASX, having operated since 1923. It has a solid track record of maintaining, or increasing, the dividend over the very long term: the company’s dividend has not declined over the past 20 years. WHF only invests in Australian industrial shares, and excluding resources shares gives it lower relative volatility. In the year to March 2018, the company said its strongest contributors to its performance included A2 Milk, Flight Centre, Qantas, Treasury Wines, Cochlear, Aristocrat, ResMed, Boral, Metcash, IAG, CIMIC (the former Leighton), Computershare, CSL and Macquarie Group. With no ETF that specifically provides industrials exposure, Whitefield represents a cost-effective option for investors looking for this discrete exposure.
Diversified United Investments (DUI, $4.05)
Five-year total return: 11.6% a year
Historical FY17 dividend yield: 3.9%, fully franked
Pre-tax NTA: $4.31
Discount: 6%
Operating expenses: 0.07%
Founded in 1991, DUI has been a sound performer in recent years. Its portfolio is heavily weighted (more than 70%) to Australian large-cap shares, but DUI also offers some exposure to offshore markets – targeting up to 15% in international shares – which it achieves by investing in international ETFs. It has one of the cheapest management costs of Australian LICs.
Flagship Investments (FSI, $1.66)
Five-year total return: 9.3% a year
Historical FY17 dividend yield: 4.7%, fully franked
Pre-tax NTA: $1.961
Discount: 15.3%
Operating expenses: n/a (There is no fixed management fee. EC Pohl & Co receives a fee that is performance based and payable yearly in arrears.)
A smaller LIC – capitalised at $42 million – Flagship Investments’ focus is on Australian growth companies, with the portfolio management team headed by well-known manager Manny Pohl. The small market cap provides some explanation for the discount, but Pohl’s team has a different-looking top ten holdings list to most of its peers, featuring stocks such as Carsales.com, Domino’s Pizza, Pendal (the former BT Investment Management), Magellan Financial Group and global plumbing supplies leader Reliance Worldwide. Flagship’s dividend yield track record is particularly good: it does not have the highest dividend yield in the sector, but those that do – which get up around 6%, fully franked – trade at premiums to NTA.
Thorney Opportunities (TOP, $0.68)
Three-year total return: 16.4% a year
Historical FY17 dividend yield: 1.8%, fully franked
Pre-tax NTA: $0.807
Discount: 15.7%
Operating expenses: 0.75%
Thorney Opportunities is a very different beast to most of its peers in the LIC sector: where most of them are focused on the market’s highest-quality stocks and generating fully franked income – meaning that there is a high degree of portfolio overlap – Thorney Opportunities, when it launched in December 2013, was the retail investor’s first chance to invest with star fund manager Alex Waislitz, who has been described as “Australia’s Warren Buffett” because of his long-term success in compounding returns. Waislitz’s $1.39 billion fortune has all been made from a parcel of shares worth $1.15 million, with which he started investing on the stock market 25 years ago, mostly investing on behalf of the Pratt family, into which he was married. Waislitz is regarded as one of the very best stock-pickers in the ASX small-cap and micro-cap sectors, in which he has captured big stock rises in companies such as superannuation technology platform Hub24, logistics tech company Yojee and payments technology company Afterpay Touch, among many others. Waislitz has since launched another LIC, Thorney Technologies, which was listed in December last year, and focuses on listed technology companies and unlisted start-ups. Thorney Technologies (TEK) currently trades at a 3.2% premium to pre-tax NTA.
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 regard to your circumstances.
