Buying $1 of asset for 80 cents looks like a no-brainer. Particularly when that $1 of assets involves liquid shares that are valued on the stockmarket by the second.
This scenario is readily available in the Listed Investment Company (LIC) sector at current prices but the opportunity is not as straightforward as it seems. Some LICs trade at a big discount to their pre-tax net tangible assets (NTA) for a good reason; others are a bargain.
To recap, LICs are essentially a type of listed managed fund. As its name suggests, an LIC is a company that manages a fixed pool of capital that invests in Australian or international shares, or other asset classes. That investment pool can be expanded through capital raisings.
Shareholders own shares in the LIC company, not its underlying fund. This is an important distinction with unit trusts where investors buy and sell units in the fund.
Unlike a unit trust, an LIC’s share price can deviate significantly from its underlying NTA. Some LICs trade at a discount to their NTA because the market is concerned about the manager’s investment record, asset class, dividend history or its portfolio liquidity.
Other LICs trade at a premium to their NTA. Investors are willing to pay more for the LIC than its assets are worth because they rate the LIC’s management and performance prospects. They believe the LIC’s NTA will keep rising and the share price will follow.
Some good judges I know pay close attention to LIC discounts and premiums. They buy high-quality LICs when they trade at an unusually large discount to their NTA, and sell those trading at an unusually high premium. Rarely is it a good idea to pay more for assets than they are worth.
These investors look for cycles in the LICs when discounts are unusually large relative to historical average – such as now. LICs have a tendency to revert to their mean discount or premium over time, providing an opportunity for eagled-eyed investors.
Consider the current LIC market. About three-quarters of LICs traded at a discount to their NTA at the end of January 2019, ASX data shows. Only a handful of LICs traded at a double-digit premium to NTA. The size of LIC discounts, in aggregate, seems unusually large.
Three reasons explain the big discounts. First, the LIC sector is yet to recover from the broader sharemarket sell-off in the fourth quarter of 2018, when listed investment vehicles were especially hard hit. LIC buyers have been harder to find in an uncertain market.
Second, the Labor Party’s controversial proposed reform to dividend imputation credits may have hurt LIC sentiment. Many Self-Managed Superannuation Funds (SMSFs) have invested in LICs for dividend yield and franking credits.
LIC fatigue is probably the third factor driving the discounts. There was a boom in LIC Initial Public Offerings (IPO) in the past five years as several well-known fund managers launched investment companies to reach the SMSF market via ASX. In several cases, there has not been new LIC buying to absorb the extra supply and discounts to NTA to have featured.
At least two of these factors are heading in the right direction for LIC investors. The sharemarket has rallied since its fourth-quarter lows and LIC NTAs in theory should inevitably move higher, as should LIC share prices that track the NTAs.
There has been a slowdown in LIC IPOs in the past year. Although there is talk of LIC IPOs returning to market, I can’t see a rush of new supply comparable with previous years. More likely is several listed investment trusts coming to market.
Labor’s franking-credit policy is concerning, particularly with opinion polls showing the Opposition will win the Federal election. But LICs can manage the change and some might convert to listed investment trusts to have more dividend flexibility and get around the franking-credit changes.
As to specific LICs, the usual rules apply. Favour LICs run by high-quality managers that have a consistent record. Compare the current discount or premium to the average of the past five years where possible, and determine if the LIC is trading too far beyond its usual pattern.
Specialist tech investors Bailador Technology Investments is an example. It traded at a 34 per cent discount to its NTA at January 31, 2019, ASX data shows. This time last year the discount was 22 per cent and in January 2017 it was 19 per cent.
Bailador last year had its first IPO from its portfolio of unlisted tech companies – Straker Translations – and has a few other companies in its portfolio that should be IPO candidates in the next few years – a point at which value could be unlocked in those companies and Bailador’s NTA.
Chart 1: Bailador Technology InvestmentsSource: ASX
• Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation and needs. Do further research of your own and/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 March 6, 2019.