The boom in Listed Investment Companies shows no signs of slowing, judging by the number of LICs wanting to list on ASX through floats. Two LICs are on the Initial Public Offering runway and several more, including some from big-name mangers, are lining up to list.
By my count, just under a third of the 90 ASX LICs at July 2016 have listed in the past three years. That eclipses the 2004-06 LIC boom when 22 came to market. The wider variety of LICs listing in the current boom is another feature.
The sector’s combined market capitalisation has grown from $25.9 billion in July 2014 to $30.3 billion in July 2016, ASX data shows. That’s a good result in a sluggish market, but LICs are still tiny compared with Australia’s trillion-dollar unit trust market.
Expect continued strong growth. Financial planners are showing greater interest in LICs after Freedom of Financial Advice (FOFA) reforms that banned conflicted sales commissions to advisers. Previously, there was far more financial incentive for advisers to recommend unit trusts.
The market’s love affair with regular, fully franked dividend yield is also boosting demand for LICs, which are essentially listed managed funds that trade on ASX.
Many LICs, because of their closed-end structure, offer competitive, fully franked yield that appeals to SMSF trustees and income seekers. Their structure means the underlying LIC portfolio is not affected by fund inflows and outflows, unlike unit trusts. In theory, that boosts the reliability of LIC dividends and franking credits.
The LIC market’s profile is rising. Prominent fund managers such as Perpetual, PM Capital and Investors Mutual have launched LICs in the past two years. More are expected to follow.
Investors Mutual is reportedly launching a new income-focused LIC and Antipodes Global Investment Partners is raising up to $330 million in its IPO. The India Fund is another live LIC IPO.
Understand the risks
Like all investment products, LICs have their downside. Several trade at persistently large discounts to their pre-tax net tangible assets (NTA), meaning the LIC is worth less than the assets it holds – a trend that frustrates LIC managers and shareholders alike.
Also, the LIC’s fixed capital pool (which can be increased with capital raisings) means the manager secures its fee, even if performance is lousy.
Moreover, some LICs have a nasty habit of raising capital when the share price trades at a big discount to NTA, so they boost funds under management and earn more fees. That effectively transfers wealth from existing shareholders to new investors who subscribe to the capital raising.
Nevertheless, investors should pay more attention to LICs. The closed-end structure has advantages over open-ended mutual funds that sometimes have to sell stock when markets fall, to meet fund redemptions, or buy stock when markets rise and fund inflows are strong.
Being listed on ASX also means they have an extra layer of regulation and scrutiny. LICs have boards, report bi-annually, produce a monthly NTA report, have an annual general meeting and investors know what the LIC holds. They are more transparent than unit trusts and can be bought and sold faster and easier via ASX.
Unit trusts play an important role in portfolios, but I sense more momentum in listed or quoted funds, such as LICs or exchange-traded funds, is building.
Three LICs closing the NTA gap
This column has had some good success with LICs in the past 12 months. It identified Contango Microcap in late 2014 when it traded at a hefty discount to pre-tax NTA and has written about Clime Capital, another LIC a well-regarded fund manager that has traded at a relatively large discount to its NTA in the past few years.
Bailador Technology Investments, an interesting LIC that specialises in growth-stage unlisted technology companies, was positively reviewed for The Bull in 2015.
Contango has rallied this year, partly because its underlying asset class of micro-cap stocks is outperforming and also because the fund’s profile and market communication have vastly improved. Yet the LIC still traded at a 16 per cent discount to NTA at July 2016, latest ASX data shows.
Chart 1: Contango MicrocapSource: The Bull
Clime Capital looks like it is starting to turn after a tough few years. A share buyback, broadening of its portfolio style to include more small-cap and pre-IPO companies, and expiry of a preference share in March next year (the servicing of which has weighed on its NTA), are good signs. Clime traded at a 10 per cent discount to pre-tax NTA in July 2016.
Chart 2: Clime CapitalSource: The Bull
The impressive Bailador has come back a little after strong gains earlier this year. It traded at a 3 per cent discount to pre-tax NTA in July, a good effort because most LICs, especially smaller ones, tend to trade at a discount as they build their investment performance record.
Chart 3: BailadorSource: The Bull
The three LICs mentioned can be bought for less than their assets are worth. Ideally, LICs should trade at a minus 5 per cent to plus 5 per cent range around their NTA. Beware those trading at a premium well above that – and their historical average – because the market may be extrapolating the LIC manager’s past performance too far into the future.
LICs trading at discounts greater than minus 5 per cent deserve closer attention, with some caveats.
Check how the discount compares with the LIC’s average over five years and the fund’s underlying performance. If the LIC trades at a larger-than-usual discount, and its underlying portfolio is consistently matching or exceeding its benchmark index, the LIC could be undervalued.
Another signal I look for is LICs that trade at double-digit discounts to NTA and have a poor market profile and weak investor relations.
A handful of LIC chief investment officers are great marketers, but too many are more comfortable analysing an earnings announcement than presenting to investors, analysts and the media. Some LICs get a good kick along when they start to explain their story clearly and more consistently to the market. The gap between NTA and the share price starts to narrow.
LICs to watch
Two recent LICs worth watching are the Glennon Small Companies Fund and the Monash Absolute Investment Company.
Small caps are outperforming large caps this year, Glennon has a solid record and its recent performance has been good. Glennon announced in August that its portfolio had risen 26. per cent since the LIC listed in August 2015.
Yet Glennon traded at an almost 11 per cent discount to pre-tax NTA in July 2016 – probably because it is a small LIC IPO with limited history as a listed investment vehicle.
Chart 4: GlennonSource: The bull
The Monash Absolute Investment Company is one the few absolute-return funds listed on ASX. Such funds aim to produce a positive return in rising and falling markets, using buying and short-selling strategies. Like Glennon, the Monash Absolute Investment Company has delivered good early performance but it trades at a 7 per cent discount compared to its latest stated pore-tax NTA.
Chart 5: Monash AbsoluteSource: The bull
Both LICs suit investors who are comfortable with LICs that invests in risker stocks (Monash also invests in blue-chips and is company-size agnostic).
Tony Featherstone is a former managing editor of BRW and Shares magazines. The information in this article should not be considered personal advice. The article has been prepared without taking into account your objectives, financial situation or particular needs. Before acting on the information in this article you should consider the appropriateness of the information, with regard to your objectives, financial situation and needs. Do further research of your own or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at Sept 7, 2016