Listen to any stock selection advice and everyone will say they look for good management. This is right up there as the most important box to tick – and it’s even more important when it comes to looking at a listed investment company, because what you are investing in with an LIC is the management’s stock picking ability.
But there’s a catch. You are not an institutional investor with pockets so deep you open boardroom doors all over the country. Maybe you run an SMSF or a private portfolio and only have access to a prospectus and Google. What do you look for? Let’s get box ticking.
A word before we start: not many LICs will tick all of these boxes. In fact I don’t think any will. That’s ok, as long as they hit some on this checklist:
Skin in the game
Just like when looking at small cap stocks, with LICs you want someone at the helm who has a vested interest. Do the chief investment officer and directors hold enough stock in the LIC to feel the pain when shareholders do? Do they back themselves and buy more stock when the price falls? That surely is a tick of confidence.
What you can look for exactly? When scrolling through announcements, look for an appendix 3Y. This is a change of director’s interest notice. It will tell you when they have bought and sold shares. Additionally, look at the last annual report. Generally in the last few pages of the report you will find the top twenty shareholders and substantial shareholders.
Chris Stott from Wilson Asset Management holds shares across all three of the LICs he manages. Sometimes this will not immediately be clear which parties own what, but with the help of a Google search you can find out. For example, one of the two substantial shareholders for Cadence Capital is Esselmont Pty Ltd, which is a company with Karl Siegling, Cadence’s portfolio manager, listed as the director. PM Capital’s two LICs have Roaring Lion Pty Ltd listed towards the top of the top twenty shareholders and a quick Google search shows these to be directed by chief investment officer, Paul Moore.
Unfortunately, it is not always obvious if the portfolio manager holds shares if they are not a director of the LIC. Keep an eye out for presentations and shareholder briefings or contact the LIC directly and ask the question.
Where have they been? What have they done?
With the help of search engines and websites such as LinkedIn you can see where a manager has worked previously . You can then see which funds they were involved in and you can then look them up and see what the track record was.
Let’s consider a few recent listings. Looking at the people and the backgrounds behind them will go a long way to show us why some capital raisings were more successful than others.
One of the most recent raisings was the Absolute Equity Performance Fund (AEG). This IPO was very successful and it has come on to the market since. AEG raised $100 million through the IPO and since listing, the share price has raced from $1.10 to sit now at $1.31 in a short period of time. The share price performance is not indicative of the underlying portfolio performance. The NTA sits a shade above the listing price.
Why the success without any underlying performance? AEG comes from Richard Fish and the team of Bennelong Long Short Management. The team have won and been nominated for several industry awards over the years and have been working on the same strategy in a wholesale unlisted managed fund since 2002.
The absolute maximum, including over subscriptions, allowed was $100m and that is what they raised. If they wanted more, they could have got it.
Contrast this with another LIC IPO around the same time, Henry Morgan Limited (HML). This portfolio is managed by Stuart McAuliffe. McAuliffe managed the Aliom Managed Fund No 1 prior to being appointed the manager for HML. This fund had approximately $3m under management and had a spectacular track record returning 99 per cent pa since 2012. It is almost too good to be true : Investors appeared to agree with this interpretation and the IPO scraped over the line.
These are two extreme examples, but investors were happy to pile into AEG while they will sit back and wait for McAuliffe prove himself first. Of course marketing and media comes into play and HML was never going to get the attention AEG did.
For another example of how much track records count, keep an eye out for the WAM Leaders Fund when the prospectus is doing the rounds.
Is the LIC the manager’s main focus? Are they managing other funds that are bigger than the LIC and therefore more important as far as fees are concerned to the manager's overall business? How can you measure this?
Look at the underlying manager of the fund. This is the investment company receiving the fees. For some LICs, it may not always be apparent. Look the manager up and see what other funds the company currently has under management. Look at the size of the LIC and the annual report and see what the fees are worth to the manager. Does this make a difference to the manager's overall business?
This may not always be appropriate for all managers. Consider Thorney Opportunities Fund (TOP) for example. The LIC operated by Thorney does not play a major role in bringing in management fees for the group. What it does is provide a clear and public track record for the group. It also provides a public face for the group’s occasional agitating. The performance is important and the results do count.
Attitude towards fees & growing the LIC
There are three reasons managers look to grow the funds under management – generating more management fees that are permanently locked in, taking advantage of an opportunity the manager sees coming up and for the benefits of scale.
There is a fair way to do it and a not so fair way. Go through the past announcements of the LIC you are looking at and see if it has raised FUM through the issuing of options or placements. The issuing of options is fair for all shareholders involved. One of placements to institutional or wholesale investors is not fair on all shareholders, and dilutes shareholders without them having any say.
Look to see if this has an effect on the management expense ratio (MER). For example, BKI has actively lowered its MER as it has increased FUM. The costs of running the portfolio are fixed, and management has not looked to line their pockets further by keeping the percentage fixed. This is an example of management aligned with shareholders as they are shareholders themselves. As they said in the most recent presentation, “the thicker the carpet the thinner the dividend”.
Spruiking matters. Portfolio managers may be far more comfortable with their heads buried in company reports and have little interest in marketing fluff pieces or pressing the flesh, but it is necessary.
An LIC manager needs to communicate their strategy to the market effectively. If investors understand what the manager is trying to achieve and can see why they did or did not achieve the results, this will go a long way in helping build trust. This trust and confidence will help keep the NTA aligned with the share price or even above.
How can you see who is actively promoting? I have set up what is called a Google Alert. You can set this up for any word or term you are interested in and each day you will receive an email with links to articles and new web content that uses the word or term you have entered. I have set an alert for the terms “Listed Investment Company” and “LIC”. I can probably discontinue the LIC alert because all I seem to get is Gumtree ads for licensed trailers. If I ever need a trailer in a hurry I am sorted.
Trailers aside, I receive notifications of who is proactively engaging with the media and being mentioned by publications. It is a good indicator of who the busy spruikers are. And just a hint, they are the ones who typically trade at a premium.
Additionally, read the quarterly and monthly updates from the LICs. I favour those who give more information. I also like those who give you realistic information about the returns. When I say realistic I mean returns that is net of all fees, not pre fee.
Does an LIC have to do all of the above?
Not too many LIC managers will tick all of these boxes, and they don’t have to. In the model portfolio there are LICs that do the opposite of some of the things written above, but still have favourable features that other LICs don’t. The more the better, of course, but this isn’t a definitive list of criteria. If none of the above are ticked? Avoid. Do not force a round peg through a square hole. Move on to a portfolio you understand and comfortably satisfy the majority of your criteria.