Overcoming the NTA conundrum

Mitchell Sneddon answers Eureka readers' most common LIC questions.

Summary: In this LIC Q and A: how to calculate NTA, choosing an international LIC, looking to Asia and how to watch the market before buying.

Key take-out: When it comes to knowing whether an LIC will trade at above or below NTA, patience is key - consider past performance and personnel, but don’t rush into any decisions.

Key beneficiaries: General investors. Category: Listed Investment Companies. 

Two weeks ago we threw open the doors for your LIC questions and you did not disappoint - the correspondence was flying in. We were able to address the questions that came through early in a ten minute webcast which you can watch below. I’ll address some of the rest today.

There were two strong recurring themes among the questions we received: How to view the relationship between net tangible assets (NTA) and share price, and how to gain more international exposure through LICs. Because of this a number of questions overlapped, so if you do not see your name below and you sent a question through do not despair - I’ve attempted to address your question through other similar ones.

As for the video, here are the main ideas we addressed:

  • LICs focusing on small cap stocks,

  • Companies with greater exposure to materials and resources,

  • How much cash we can expect LICs to hold as a proportion of the total portfolio.  

LIC price vs NTA rightly important; so can you give us quick method?

-Peter

Hi Peter, LICs must report NTA numbers at the end of each month. Some choose to do it weekly and there are a handful that even do it daily. What investors need to keep an eye out for is if the LIC reports its NTA post or pre fees and expenses. This can change the performance of a LIC from one that has outperformed to in line with the market or even underperforming on some occasions.

The method for calculating a LIC’s NTA is pretty straight forward. They just take the value of the portfolio including cash on the close of day, week or month and divide it by the number of shares on issue.

What some people also try to do is calculate the interim NTA, meaning if you know the breakdown of a large portion of the portfolio and you know the manager does not trade a lot, you can try to calculate what the NTA is going to be at any given point. You will need to know the share price and the weighting of the stock in the portfolio.

An easy one to do this with is Thorney Opportunities Limited (TOP). The portfolio does not turn over often, there are a small number of holdings and we know the weightings of these. You can get a fairly accurate guide to how the portfolio will do month to month and take advantage of price fluctuations.

I know everyone talks about buying LICs below the NTA. I'm interested to understand if and how you think about the P/E ratio of LIC's. My concern with just buying at a discount to NTA is that market psychology and the ability of the fund manager to market his/her product plays a part in the price of the shares.

- Troy

Hi Troy,

You are right to be concerned, the manager’s ability to not just perform well but to tell people about it will affect your investment. Having a great product is one thing but you also need a good marketing department. Your investors need to understand how you invest and why you invest that way. A consistent message is one that shows the two key things in funds management: People and process. This is what will help keep the gap to NTA tight. Also dividends help as well.

If you think about it, trying to measure a LIC by a price to earnings ratio would be near impossible. A LIC’s earnings are made up from realised and unrealised capital gains and dividends received. Being able to estimate a forward looking PE would mean you’d need to get a measure on what each individual holding is going to pay as a dividend and potential share price growth. And remember the information we receive as shareholders is backward looking. A stock held by a LIC at its last monthly update might not be held by the time the next month rolls around.

The best way to measure a LIC is by the NTA but you cannot just go out there and buy the one at the biggest discount. Just because a basket of stocks is cheap doesn’t mean it’s good and sometimes even when it is good if the manager fails to effectively communicate with the market than it’ll remain cheap.

When assessing a cheap LIC I like to see if it typically trades at or above NTA generally speaking – and if perhaps negative market sentiment has driven it down in the short term. Has something changed? A change in personnel? Or maybe just a large seller as these LICs can tend to be quite illiquid. Unfortunately as someone who invests in LICs we need to take into consideration the immeasurable impact market psychology and the power of marketing.  

Can we have a run down of some of the newer international LICs available on the ASX?

 - Peter

A lot of the new international LICs have been Asian-focused - and they are trading cheaply because they have felt pain, most notably, Ellerston Asia, and to a lesser extent Platinum Asia. These are two LICs with exposure to China and there has been a lot of negative sentiment towards that region since these two listed. They have not had a good time of it. Platinum is holding its own as far as share price to underlying value is concerned, but Ellerston has been hit fairly hard and that could provide investors with opportunity.

What investors need to remember is despite having a significant exposure to China, these funds, PM Capital Asian Opportunities Fund included, have exposure to India and southeast Asia as well. This also opens them up to having multiple currencies to handle on top of the selecting individual companies. And that is what these guys are doing at the end of the day, investing in businesses. As Kevin Bertolli from PM Capital has reminded me, when people decide to buy emerging markets they typically will buy a whole basket of them and when they choose to sell they will sell the lot, throwing out the good with the bad.

Depending on your view on Asia you can get cheap exposure to that area through PAF and EAI. AMP Capital China Growth (AGF) still trades at a deep discount as well but as we previously highlighted in an article on AGF, Agitating for Value - to read it, click here - there are a number of issues facing the LIC coming into the Extraordinary General Meeting in July. Agitation issues aside, what investors must know is AGF provides you with direct exposure to China and that is essentially it. The fund has a very tight mandate which is designed to allow little variance from the index.

As far as globally focused LICs, aside from Magellan Flagship Fund which we have covered extensively currently Hunter Hall’s HHV stands out (click here to read our full write up and watch the video with Peter Hall). The portfolio has performed well and with Hall back in the country the opportunity to get out there and market the LIC appropriately will help to close the gap to NTA.

For broad global market exposure, investors may want to look at Templeton Global Growth (TGG) which is trading at a 10 per cent discount to pre tax NTA at the time of writing. The Future Generations Global Fund (FGG) is also an intriguing proposition for those who want broad global coverage. FGG is a fund of funds where your management fees go to youth mental health charities. Also presenting good value right now is PM Capital Global Opportunities Fund (PGF). Run by Paul Moore, it is a high quality portfolio trading at a 15 per cent discount to pre tax NTA at the time of writing.  

I am interested in LICs but it seems that many of them trade seemingly forever at either premiums or discounts to NTA which just does my head in !and it worries me buying into either situation. At a premium I may be paying too much only to later perhaps see the premium fall away thus costing me future gains, whereas at a discount I worry the market sees problems with the LIC that perhaps I am missing. Any suggestions as to how to deal with this issue?

- Carlos

Carlos, this is the conundrum a lot of investors face when looking at LICs. No one wants to pay too much for any stock, but they do, and rightfully so people are wary of buying an LIC at a discount and having that gap never close.

To avoid buying LICs that trade at a discount but will never close the gap, look for LICs that have a history of trading at or above NTA. This tells you the LIC in the past has been able to get all of the intangibles aligned (think marketing and communication) as well as performance and generally speaking, a consistent dividend.

Check to see there hasn’t been any changes to the management of the portfolio e.g. key staff still managing the portfolio, for this look at announcements or call the LIC directly. If all is in order it could just come down to negative sentiment and that is something we want to take advantage of. But remember, sentiment can take some time to turn. Just look at the Asian focused LICs.  

As you mentioned, you do not want to be buying above NTA just to have the share price correct back to the underlying value. This is something we highlighted with Cadence Capital - click here to read it.

It is a risk and when you are buying above NTA you are banking on future performance. Remember, past performance is no indication of future performance. Also when you are buying above NTA you are not factoring in the fees the LIC charges. The higher the fees the larger the discount.

The real key to all of this for an investor is patience. When you have a pocket full of cash, you may end up forgetting all of this and talk yourself into buying. After all, you don’t want to miss out! Remain patient and wait for the market to give you opportunity in quality LICs.