Argo's golden cargo

PORTFOLIO POINT: The venerable listed investment company is trading at a very attractive discount to its asset value.

Argo is a famous name in the Australian investing. As a listed investment company with a 65 year history, a record of paying dividends every year and the legendary Sir Donald Bradman a former chairman, it has an iconic place in the Australian investment landscape.

Argo is a listed investment company, meaning it is listed on the ASX (its code is ARG), with an underlying business to manage an investment portfolio. The company, and portfolio, are worth about $3 billion.

The value of the portfolio is reported as the “net tangible assets” per share (NTA). Listed investment companies have the ability to trade at either a discount to its NTA (where its share price is less than the value of the portfolio) or a premium (the share price is greater than the value of the portfolio).

This leads to an interesting opportunity around LICs. It’s also worth remembering that for all the fanfare around exchange traded funds (ETFs), there are 63 LICs listed on the ASX at the moment with a combined value of more than $15 billion – three times the value of all the assets within ETFs.

Remarkably, the majority of LICs are trading at less than the value of the shares they own; that is, their share price that is less than their NTA.

Taking Argo as an example, its share price is about $5.06 (as of today, December 16). The value of the share portfolio (NTA) was $5.46 at the end of November and, with markets up 2% over the month to date, it is likely to be worth about $5.55 now.

That means an investor can buy exposure to one of the most famous, long-running and reliable investment portfolios by paying $5.06 a share for a portfolio that has a value of $5.55 a share. The question is, should they?

One point to note from the beginning is that as well as having an NTA of about $5.55 a share, Argo (like other LICs) reports its after-tax NTA, which was $5.09 a share at the end of November. Argo emphasises that it is a long-term investor, and doesn't intend to sell its portfolio and realise those tax obligations.

In my opinion, this reporting of the tax position of LICs is a great advantage to investors: almost no managed funds provide the same clarity of tax reporting. When you consider that Argo, as with most LICs, tells you upfront the tax position of your portfolio, and the fact that Argo has only paid fully franked dividends for the past 15 years, your tax position as an investor is transparent.

Talking of dividends, you would expect that at current prices the dividend yield from Argo would be slightly higher than the dividend yield of the overall market – given that Argo currently trades at a discount to the value of the portfolio. Yet Argo's dividends for the past 12 months totalled 26¢ a share, which is a dividend yield of 5.1%. This compares favourably to the average dividend yield of the sharemarket of 4.7%.

The follow table shows the top 10 holdings in the Argo portfolio and the top 10 holdings in the ASX 200 index.

-Argo and the ASX
	Argo top 10 holdings	ASX 200 top 10 holdings
Biggest Holding	BHP Billiton	BHP Billiton
2nd Biggest	Westpac (WBC)	Commonwealth Bank (CBA)
3rd Biggest	Wesfarmers (WES)	Westpac (WBC)
4th Biggest	Rio Tinto (RIO)	ANZ Bank (ANZ)
5th Biggest	ANZ Bank (ANZ)	National Bank (NAB)
6th Biggest	Commonwealth Bank (CBA)	Telstra (TLS)
7th Biggest	National Bank (NAB)	Wesfarmers (WES)
8th Biggest	Milton Corporation (MLT)	Woolworths (WOW)
9th Biggest	Australian United Invest Co (AUI)	Rio Tinto (RIO)
10th Biggest	Telstra (TLS)	Newcrest Mining

Given the similarity of the Argo portfolio to the sharemarket index, it is not surprising that the performance has been very similar – over the past 10 years the index return has been 7.5% a year (to the end of September 2011) and the Argo portfolio return (change in NTA plus dividends) has also been 7.5% a year, according to its investor update.

One of the core advantages of Argo over many managed investments is its low cost – an MER of 0.17% is less than one-tenth of the 1.8% many managed funds charge, and among the lowest MERs available for any investment.

Of course there is the risk that Argo, or any LIC, could see the share price performance be worse than the performance of the underlying portfolio – effectively reducing the return investors receive. For example, let’s assume that the Argo portfolio increases in value to $6 a share over the next six months. There is nothing stopping the Argo share price falling in that time.

That said, a couple of factors mitigate against this. The first is that an LIC might choose to have a share buyback if the share price fell too far below the value of the portfolio; buying back shares at less than the portfolio value is a good capital management decision for an LIC. The second is that the further the value of the portfolio falls below the share price, the more attractive an investment becomes for new investors.

Investors need to be comfortable with the ability of an LIC to have a share price that underperforms the actual portfolio – which will reduce the investor’s return – and seems to make LICs like Argo most useful as long-term sharemarket investments.

Scott Francis is an independent financial adviser based in Brisbane.