Changing LIC calls: Magellan, Cadence and WAM Research

We’ve seen some standout performances from our LIC picks – now time to consider what they’re worth.

Over the last few turbulent months I have been particularly pleased with the performance of two portfolio positions which we also have calls on in our recommendations page. Cadence Capital (CDM) and WAM Research (WAX) have been exceptional recently. These two LICs are a great example of the protection a well-diversified and managed portfolio can provide investors.

In the past I have said I do not pay too close attention to the share price and a LIC’s NTA. The reason I say this is because I do not mind if an LIC is trading within a reasonable range of its NTA, above or below. What I would deem to be a reasonable range is 4-5 per cent either way. I would deem this range to be fair value and I generally would not hesitate to buy an LIC if the price was trading at a premium of around 4-5 per cent – I would consider this an upper limit. Beyond that range, you are pricing in future performance and this is something you can never guarantee in the stock market and with managers.  

Two holds

Two holdings in the LIC model portfolio have been flirting with the upper levels of what I would call a material premium to NTA. They are Cadence Capital Limited (CDM) and WAM Research Limited (WAX). In the recent downturn investors have favoured these LICs and the unconstrained approach employed to manage the portfolio. Not only has CDM and WAX held ground but the share prices have increased when we’ve seen negative returns from the majority of the market.

It is because of this share price movement I am changing the call on CDM and WAX to a hold. This does not mean if you bought both of these LICs today you wouldn’t be able to make money from them but it is unreasonable in my view to pay 12 per cent premiums for these LICs in this market. At the time of writing CDM was trading at a 12 per cent premium and WAX was trading at a 12.5 per cent premium. 12 per cent is material, especially in the case of CDM where the NTA has been dropping away.

The reason why WAX and CDM has attracted investors and increased the premiums the portfolios trade at is the very reason why we were attracted to the LICs in the first place. CDM has the ability to invest in any stock, and short any stock, the team want. This includes international shares and the mandate also includes the ability to hold 100 per cent cash. As of CDM’s last market update, the portfolio was 24.27 per cent cash.

Such an open mandate does not mean the managers’ hands are tied. The investment team have the freedom to pursue their very best investment ideas to generate returns for shareholders.

WAX has stuck to its knitting and the team at Wilson Asset Management continues to hold quality small cap stocks and a hefty amount of cash. This has provided the portfolio with a solid buffer. Also contributing to the popularity of the two LICs has been the history of dividends paid by the two. WAX currently has a grossed up dividend yield of 5.9 per cent, while CDM has a dividend yield of 6.7 per cent.

Although LICs are a low maintenance option to investing, you still want to keep an eye on them and be aware of where the price is compared to the value of the portfolio. Right now WAX and CDM in my opinion are too expensive to buy but this could change. If the price drops back in line with NTA these two are most definitely a buy again but for now new investors should be patient. Do what the LIC managers themselves would do - sit and wait for the right price.

...and a buy

Speaking of being patient, those who let Magellan Flagship Fund (MFF) run are now being rewarded with another chance to buy the highly successful global manager at fair value.

MFF reports the value of the fund on a weekly basis, including the value if the options are all exercised come 2017. Given this I believe there is no logical reason MFF should trade at a substantial premium or discount. Yet this is exactly what we saw recently with the MFF share price going for a run and reaching as high as $2.18 in late December when the NTA before tax and before taking the options into consideration was $2.102. Our call at the time was a hold.

Now, with no material change in the portfolio the MFF share price is 1 per cent above the value of the NTA after the options have been accounted for investors are getting the opportunity to buy a top performing LIC at a fair price. This is why MFF now changes from a hold to a buy.

The MFF portfolio remains of the highest quality and there’s a cool head at the helm in portfolio manager Chris Mackay. In a market correction you want to be holding the highest quality stocks. They will get hit with the rest of the market, but they will always rebound much faster than lesser quality stocks when the market recovers. For a full review on MFF and the investment strategy behind the portfolio see: Our first LIC call, Magellan’s MFF (July 13, 2015) – despite the article being half a year old, it is all still relevant.