Fancy buying $1 worth of assets for 80 cents, from a prominent fund manager, through an ASX-listed company? That opportunity is available to investors every day through Listed Investment Companies (LICs), but is not as clear-cut as it seems.
Consider Westoz Investment Company, a Perth-based LIC. Westoz traded at an 18% discount to its pre-tax Net Tangible Assets (NTA) in March 2017, ASX data shows. Simply put, Westoz is worth almost a fifth less than the market value of its assets.
Sounds like a bargain, right? Not so fast. Westoz has underperformed its benchmark index over five years and has a bias towards West Australian small-cap stocks. With the WA economy underperforming its East Coast peers, investors have marked down Westoz.
Westoz supporters will argue that 18% is too large a discount and that it is leveraged to an eventual pick-up in the WA economy. But this example shows why buying LICs based on discount and premiums alone is dangerous.
Some LICs trade at consistently large discounts to NTA, frustrating their managers and investors alike, and often putting a takeover target on the company’s back. Activist LICs are quick to pounce on underperforming LICs to get hold of their asset base and rid the company of underperforming managers/directors.
A large recurring discount might be because of the LIC’s poor investment performance, patchy dividend record or concerns about the part of the market in which it invests. Several LICs that focus on small- and mid-cap stocks, for example, have traded at discounts in the past 12 months.
Another LIC might trade at a premium to LIC, meaning it is worth more than the market value of its assets. Investors pay a premium because of the manager’s record and expectations that the underlying asset base will keep rising. Sector star WAM Capital is an example of an in-demand LIC that trades at a seemingly perpetual high premium.
I’m always wary of LICs that trade at large premiums to NTA, no matter how good the manager. It’s never a good idea paying more for assets than they are worth. Instead, search for LICs that have unrealistically large discounts to NTA; as market confidence returns in the LIC, the share price rallies, thus closing the gap to NTA.
Understanding discounts and premiums
Incorporated as a company, an LIC manages a fund that typically invests in Australian or international equities. Investors buy or sell shares in the LIC rather than its fund. In contrast, investors in unlisted managed funds buy or sell units in the unit trust.
LICs are referred to as “closed-ended” funds because they manage a permanent pool of capital. An LIC, for example, might raise $200 million in an Initial Public Offering (IPO) – a pool of capital that stays the same until additional capital raisings.
A unit trust is an “open-ended” fund because its assets under management rise or fall depending on fund inflows and outflows. Consequently, unit trusts trade near their Net Asset Value (NAV). LICs can trade anywhere from a 14% discount to a 14% premium, on average, over a market cycle, according to broking research.
ASX reports LIC discounts/premiums to pre-tax and post-tax NTA. Opinions differ on which figure should be used; I prefer pre-tax NTA. Post-tax NTA factors in all tax, realised and unrealised, but some unrealised gains may take years to occur.
Rather than view the latest LIC discount or premium in isolation, compare it to the LIC’s five-year average. LIC discounts or premiums have a habit of reverting to their median over time. An LIC that is trading at a larger discount than its historical average, and comes from a reputable fund manager, may be worth inspection.
Comparisons with five-year averages are not possible for newer LICs. But the market’s largest LICs typically have a long trading history, making comparisons between the current discount/premium and the five-year average a useful starting point.
A portfolio of five unloved LICs
Some LICs, trading at discounts to NTA, are candidates for continued re-rating over the next 12 months. I have chosen one LIC from each of the five categories that ASX uses to classify the LIC market. That provides a diversified approach and some ideas for readers who want to allocate more assets to that part of their portfolio.
1. Whitefield Limited (Australian Equities)
Whitefield, among the market’s oldest and best-regarded LIC managers, has rallied this year after a tough 2016. But it traded at a 7% discount to NTA, latest ASX figures show.
Whitefield’s focus on large-cap Australian equities with reliable, fully franked dividends suits conservative long-term investors. The well-run LIC has mostly traded at a discount over five years, despite its portfolio outperforming the ASX 200.
There’s scope for the share-price rally that kicked off in 2017 to run further over 12 months, although some profit-taking is possible after recent gains.
Source: ASX
2. Bailador Technology Investments (Australian small-cap equities)
As an investor in private technology companies, Bailador is among the more unusual LICs. Co-founded by former All Blacks rugby captain David Kirk, the LIC invests in growth-stage tech companies – a part of the market that is hard to access via ASX.
Bailador has a strong portfolio of tech companies and some clever investors behind the wheels. The illiquidity of its underlying assets, and its limited record, explain some of the discount. But a 20% discount to the underlying portfolio, based on latest ASX data, appears excessive and is at odds with Bailador’s discount history since listing.
Risk-tolerant investors who want to add disruptive emerging tech exposure to their portfolio through a diversified fund could consider Bailador.
Source: ASX
3. MFF Capital Investments (International Equities)
The LIC is managed by Chris Mackay, co-founder of Magellan Financial Group, one of the market’s savviest investment firms and an expert in international equities.
Previously known as the Magellan Flagship Fund, MFF still uses Magellan for research and other services, and mostly invests in large United States companies. Part of the new name and agreement involves paying lower fees to Magellan – goods news for LIC shareholders.
Like several international LICs, MFF has rallied this year, but remains below its 2015 share-price high. The LIC traded at an 18% discount at April, 2017 – a gap that seems unreasonably large given its management quality and Magellan relationship.
Source: ASX
4. PM Capital Asian Opportunities Fund (Asian equities)
Like most LIC IPOs, PM Capital Asian Opportunities Fund traded at a decent discount to pre-tax NTA after listing. IPO costs and options issues associated with sharemarket listings can complicate the NTA discount for newly listed entities.
PM Capital Asian Opportunities Fund comes from one of the market’s best-regarded international equities investors: PM Capital. The LIC provides exposure to Asian companies that are well placed to benefit from an expected boom in middle-class consumption in the region. I like the LIC’s strategy to find the equivalents of top-performing US companies in key Asian markets.
The LIC has an interesting portfolio of stocks and an experienced team driving the strategy. It looked cheap late last year, but after a rally this year still traded at a 7% discount to NTA. Watch that gap narrow over the next 12-18 months.
Source: ASX
5. Argo Global Listed Infrastructure
Argo is well known to Australian LIC investors through Argo Investments, the market’s second-largest LIC by market capitalisation. Argo Investments, an investor in Australian equities, typically trades at a small premium to pre-tax NTA, given its good record.
The new LIC, Argo Global Listed Infrastructure, has mostly traded at a hefty discount since listing in mid-2015. Argo’s $2-issued shares traded at $1.64 in late 2016 and have since rallied to $1.82. The discount to NTA is 7%, latest ASX data shows.
Argo is an example of an Australian fund manager launching LICs in partnership with other managers. The Argo Global Infrastructure LIC uses US-based Cohen & Steers Capital Management to run its portfolio.
Cohen & Steers has a good record in global infrastructure investing and this type of asset is a neat fit for long-term investors. Listed Australian infrastructure assets are collectively expensive and there are fewer to choose from after takeovers in the electricity sector.
Adding diversified global infrastructure exposure to portfolios, at a discount to its underlying market value, appeals. Try doing that with Australian infrastructure stocks after rallies in Sydney Airport, Transurban, APA Group and others.
Source: ASX
Tony Featherstone is a former managing editor of BRW and Shares magazines. All prices and analysis at May 25, 2017.
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.
