Spruce offering on the way as fiscal year ends

A share buyback is the only way you can legally manipulate your company's share price and get a tax break at the same time. It is also an especially useful tool around the end of the financial year, as the likes of listed investment companies (LICs) go about their "window-dressing": a euphemism for sprucing up their share prices. All perfectly legal of course.

A share buyback is the only way you can legally manipulate your company's share price and get a tax break at the same time. It is also an especially useful tool around the end of the financial year, as the likes of listed investment companies (LICs) go about their "window-dressing": a euphemism for sprucing up their share prices. All perfectly legal of course.

So it is that Djerriwarrh Investments, for instance, has Goldman Sachs conducting its on-market buyback program. Djerriwarrh can tell Goldman to buy 21 million shares, the full extent of the facility, whenever it likes, or any portion thereof.

Alternatively, it can just announce a buyback, as it has, and never buy a single share. Legally, it has no obligation to buy anything but the effect of the buyback announcement is nevertheless to put a floor under the stock price.

This week is a vital one for the LIC sector as share prices on the final day of the financial year can determine how much the LIC managers get paid.

Those with a penchant for deep cynicism claim the traditional jump in some LIC prices just before June 30 is not just a magical coincidence that occurs year after year but the upshot of the LICs buying their own shares, and shares in one another for that matter.

Some of it, the share buyback action for instance, is quite visible. But by no means is all of it apparent. Buying by one LIC of shares in another LIC does not have to be revealed unless the shareholding is above the 5 per cent disclosure threshold.

An irrepressible cynic might also be fooled into thinking the abnormally high number of bids in the market lately in, for instance, Djerriwarrh - which appeared to be the work of some party prepared to spend big to keep prices near the $3.67 mark when their net tangible asset value was $3.31 - might not have all been fair dinkum bids with fair dinkum bidders behind them.

Nor should Djerriwarrh be singled out as the only subject of alchemy in the LIC market. It is one of the big ones though. And, incidentally, it suffered a mysterious 30 per cent drop in its share price last July after the close of the 2011 financial year.

The elusive chipmunks of short-term share price appreciation are at work in some of the LICs, and many other stocks for that matter, towards the end of reporting periods.

What is fascinating though is the extent of cross-buying.

There is an element of the snake eating itself in this, or a touch of sectoral backslapping perhaps. If one LIC takes 10 per cent of another LIC, it is effectively using its shareholders to help pay somebody else's management fees.

But many LICs are related, managed by the same people that is. In such cases, when there is cross-buying it could be argued that management is propping up its own management fees.

It can also be argued that if the target LIC is trading at a big discount to NTA, the cross-buying can represent good value.

The way the typical LIC works is the manager raises money in the market, then spends it buying a bunch of shares. The managers keep a portion of the dividends from those shares for themselves, and pass the rest through to their investors via dividends.

Some LICS may burn through 20 per cent of collected dividends in administration and finance costs, although LICs are mostly low-fee guzzlers these days and very few are leveraged, apart from Aberdeen Leaders and AFIC (with its convertible note). They are, therefore, a pretty safe bet.

Does the cross-buying constitute a racket? No, says one of the pre-eminent managers in the sector, Wilson Asset Management's Geoff Wilson. "It's a bit of a gentlemen's club," he says. "We buy a position and then wait for the [NTA] gap to close or for the manager to fall over". It creates value, Wilson says, and a long-term view is required.

As for fees, Wilson points out that the bigger the LIC becomes, the smaller the fee is for all shareholders as the base fee is a fixed amount on funds under management. The sector bellwethers, AFIC and Argo Investments, charge management fees of 0.12 per cent of NTA. Newer LICs charge 1.2 per cent as they are externally managed.

Taking out a rival LIC thus becomes a scale exercise with little destruction of value for minorities.

Bigger fees only cut in with outperformance, in which instance all shareholders benefit alongside the managers.

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