Expanding our LIC coverage

We're delighted to expand our coverage of listed investment companies.

Listed investment companies (LICs) can make terrific investments. They can give an investor exposure to a broad range of companies, sectors and regions while only needing to hold a handful of stocks. They can be a great set and forget investment, if there is such a thing these days. And they can also give the savvy investor an opportunity to buy at a discount to increase their potential returns.

So we’re delighted to expand our coverage of LICs, and in this review we’re going to set out the list of stocks we plan to cover (in addition to Intelligent Investor’s current coverage of Australian Foundation Investment Company, Argo Investments, PM Capital Global Opportunities Fund and Templeton Global Growth Fund).

Closed-ended

The key feature of LICs – compared to other forms of funds – is that they are ‘closed-ended’ rather than ‘open-ended’. This means that if you want to invest in them, you need to buy shares in them from other investors (rather than apply for units to be issued to you as you would with an ‘open-ended’ managed fund).

Key Points

  • Expanding LIC coverage

  • Prefer LICs trading at discounts to NTA

  • Two LICs added to Buy list

This means that the price you pay can be disconnected from the underlying value of the fund (as measured by net tangible assets, or ‘NTA’). For value investors that’s obviously an attractive feature, but investors should be careful not to just select the LIC with the deepest discount to NTA because, more often than not, the discount will persist.

Care also needs to be taken with the NTA figure itself, because it might have changed since it was last reported. If the market has fallen since the latest NTA update, then a fund’s NTA is also likely to have fallen, thereby increasing any premium or reducing any discount (and vice versa if the market has risen).

So some adjustment may need to be made. You can do this crudely by assuming NTA has changed along with the market, or more precisely by considering the movements of the LIC’s largest holdings (although bear in mind that they might have changed). The more an LIC positions its portfolio differently to the market (which is generally what we like to see) the more you’ll want to take the latter approach.

Thankfully, though, LICs are getting better at reporting, with a number of the ones below reporting weekly NTA updates and one of them even reporting daily.

Discount to NTA

All things being equal, we like to see a discount that’s sufficient to make up for an LIC’s charges. So if you expect your investments to return 8% and an LIC charges 1% a year, then you’re losing one eighth of your return – that is 12.5% – and you’ll want to buy the LIC at a discount of this amount to get you back to square.

We may be prepared to relax this a little where we particularly like an LIC’s management and think they should outperform over time. (See our special report – An in-depth look at LICs – for more about valuing LICs, but note that the report is eight years old so the specific recommendations no longer apply.)

Note also that this is what we’d generally need to see clear value in an LIC – compared to making direct investments yourself – and therefore to make it an outright Buy. If you don’t want to pick your own investments then you will have to bear some costs, so it would make sense to only discount an LIC’s NTA by enough to overcome any extra costs above what a low-cost index tracker might charge. This lower hurdle may bring some of our better Hold recommendations into range, and we’ll try to point this out where appropriate.

Our LIC coverage list will change over time depending on where opportunities can be found. There will at times be some noticeable absences. WAM Capital, for example, is not on the list as it has traded at an excessive premium for a long time. That’s not to say you can’t make money from it, but as value investors we are looking for a disconnect between price and value and we’re unlikely to find that any time soon in WAM Capital.

Over time we’ll write full reports on all LICs listed below and hopefully conduct interviews with their managers. In the meantime, here are some brief summaries to get us started.

PM Capital Asian Opportunities Fund (PAF)

Even though its options have now expired, PM Capital Asian Opportunities Fund continues to trade at a substantial discount to its net tangible assets (NTA) – currently 16% based on pre-tax NTA, which it reports weekly.

PAF gives you a portfolio of Asia-focused businesses. This might sound obvious but portfolio manager Kevin Bertoli is constantly trying to remind people of it: you are not just buying ‘emerging markets’; you are buying a portfolio of businesses. 

Table 2: PAF top ten positions at 31 Aug 16
Position Geographic exposure
51job China
Donaco Thailand
HSBC Hong Kong / International
Baidu China
Sinopec Kantons Hong Kong / China
Turquoise Hill Resources International
Zhaopin China
MGM China Macau
PAX Global Hong Kong / China
Carlsberg Brewery Malaysia Malaysia
Source: Company reports  

Bets on the consumer services sector have worked out nicely for PAF recently, including its exposure to gaming. Bertoli noted recently that visitor numbers had been increasing in Macau, which will have contributed to a near-doubling of two of PAF’s larger investments, Wynn Macau and MGM China, since January. He has a four to five-year time horizon and thinks earnings for these companies could increase significantly.

PAF follows the same strategy as PM Capital’s unlisted Asia managed fund, which Bertoli also manages and which has returned 15.5% a year since inception in 2008 (after fees). That compares to only 7.1% for its benchmark, the MSCI Asia (ex-Japan) Index.

PAF incurs a management fee of 1% plus a performance fee of 15% of any outperformance over its benchmark. To compensate, for this, however, investors are getting a 16% discount to pre-tax NTA and a 13% discount to post-tax NTA.

With capable management, PAF offers an attractive means of getting exposure to a portfolio of Asia-focused businesses. Note, however, that the stock is fairly illiquid, so patience may be required when acquiring stock. If a discount to NTA is part of your investment case (as it is here), then you need to make sure you don't compromise on that discount. BUY.

Hunter Hall Global Value (HHV)

Currently trading at a 6% discount to pre-tax NTA and sitting level with post-tax NTA, HHV has a portfolio of global stocks (including Australian) that has run away from its global competitors of late.

The cause of the recent outperformance has been the portfolio’s exposure to Australian gold producers, which makes us wary, particularly since its previously hefty discount has narrowed. As we explained in The truth about gold stocks, success in this area has more to do with luck than skill.

The gold exposure reflects HHV’s bearish view of the world.

‘The expectation of rising US interest rates is one of the most anticipated events in the history of financial markets, yet we continue to see violent moves in the US market as the prospects of this reality waxes and wanes on a daily basis. As a contrarian investor HHV seeks to exploit irrational market behaviour and, with a cash stockpile in excess of 20%, we are well positioned to do so. At the same time we maintain solid exposure to the gold price as a hedge against the inherent fragility of financial markets following almost a decade of quantitative easing,’ explains deputy chief investment officer Jonathan Rabinovitz.

HHV also promotes itself as ethical and it’s the only LIC that does. So if you want to invest in LICs ethically and you agree with HHV about what that entails, then this LIC might still be worth a look despite its relatively narrow discount – particularly if you have a bearish outlook about markets. For most people, though, we’d say the stock is a HOLD.

Bailador Technology Investments (BTI)

Bailador Technology Investments is an LIC that invests in unlisted technology companies focused primarily on ‘cloud technology’ and ‘software as a service’. Co-founded by Trade Me chairman David Kirk and private equity investor Paul Wilson, the LIC isn’t interested in startups, but invests in the ‘expansion phase’ of businesses. This means it invests in businesses with established revenue streams that are in need of fresh capital to expand.

BTI takes board representation in its investments and contributes its strategic expertise as well as its wide network of connections. Although listed in Australia, BTI’s investments are spread across the globe, including its largest investment, Siteminder, a provider of hotel room management systems, which just opened an office in Ireland. 

‘We have nine investments in our portfolio of well-established technology companies. Our companies are all growing fast and most have extensive international operations. All up our companies employ over 800 people and 58% of their revenue comes from international markets,’ says David Kirk.

BTI gives investors an opportunity to access private equity investments but beware – the immaturity of its investments and the fast-changing IT landscape makes it high risk. BTI is currently trading at a 2.8% discount to post tax NTA and a discount of 9.4% pre-tax. Note, however, that there is some subjectivity over the valuation of its investments because all of them are unlisted. HOLD.

BKI Investment Company (BKI)

BKI belongs in the same league as the likes of AFIC and Argo, offering diversification among Australian equities, with incredibly low fees, lower even than those charged by most exchange traded funds.

Last week BKI said that, as from November 1, it would switch from being internally managed, where it pays no management fee and employs its own analysts, to an external management arrangement.

This goes against the grain somewhat. As LICs grow bigger it typically makes sense for them to switch the other way. In this case, however, we think it makes sense. BKI is still relatively small (at just below $1bn) and the idea is that outsourcing its management will enable it to get the benefit of an expanded analyst team, while keeping its management expense ratio close to its incredibly low current levels of around 0.16%.

The new management company will be called Contact Asset Management and will be operated by BKI’s current chief executive Tom Millner and portfolio manager Will Culbert. Together they will own 80% of Contact, with Soul Pattinson owning the remaining 20%. BKI will pay a flat management fee to Contact of a lowly 0.1% of its total assets, with no performance fee.

Reflecting on the portfolio Millner said: ‘BKI has been listed for almost 13 years now and has been providing shareholders with an increasing income stream of fully franked dividends and capital growth. While there are some challenges in the economy, we believe the BKI portfolio is well placed to continue to capture income we can pass onto our shareholders. As long-term investors, we welcome periods of volatility as it gives us an opportunity where we can to add to existing holdings of those businesses that we like. We are constantly looking for businesses that offer an attractive and sustainable yield, are well managed, appropriately geared, have a favourable earnings outlook and are appropriately priced.’

Worthy sentiments and, with the current share price standing at a discount to NTA of close to 2% pre-tax and close to a 5% premium post-tax, we recommend you HOLD.

Perpetual Equity Investment Company (PIC)

Perpetual Equity Investment Company invests predominantly in Australian listed securities, with ‘typically a mid-cap bias’, together with ‘opportunistic allocations to global listed securities’. Exposure to overseas stocks is capped at 25%, as is exposure to cash, deposits and senior debt.

As the name suggests, the fund is managed by Perpetual and specifically by Vince Pezzulo, a senior portfolio manager at Perpetual who is the manager for 70% of its industrial share strategy. Perpetual has a team of six portfolio managers and 12 equities analysts and we have a high regard for its value investing approach, which has delivered success over many years. Perpetual charges a fee of 1% of net assets each year. 

Table 1: PIC top six positions at 31 Aug 16
Position Geographic exposure
Woolworths Australia
Suncorp Australia
Royal Philips International
Sky Network TV New Zealand
Icon International
Realogy USA / Int'l
Source: Company reports  

Seeing little value in either ‘the yield trade and the very long duration stocks (high PE)’, PIC is currently positioned defensively. ‘All of our investments have good balance sheets and will be able to navigate their way through any market turmoil,’ says Pezzulo confidently.

The largest investments in Australia currently include Woolworths, Suncorp, Sky Network Television, BlueScope Steel and GrainCorp and at 31 August these comprised 35% of the portfolio’s value. The largest overseas holdings are Royal Philips, Icon plc (a Dublin-based global contract research business) and Bank of America, which together account for a further 19%.

No doubt reflecting the difficulty in finding decent businesses at attractive prices at the moment, the fund was 23% in cash at the end of August, meaning that cash and the above investments comprised 77% of the portfolio’s value at that date.

PIC no longer has any options overhanging its ordinary shares, which currently trade at a discount of 10% to pre-tax NTA (which it reports daily) and a discount of 9% to post-tax NTA. That’s perhaps not quite enough to discount the 1% in annual fees, but we’re willing to make allowance for Perpetual’s disciplined value investing approach and great track record. With a discount at least in the high single digits, we rate PIC a BUY.

Magellan Flagship Fund (MFF)

Not to be mistaken with all of the other Magellan managed funds, this LIC is solely managed by Chris Mackay. He can make use of the research conducted by the investment team at Magellan Financial Group but the buck begins and ends with him.

The portfolio is highly concentrated and has a focus on quality. As he has often explained in his monthly reports, Mackay is reluctant to move into lesser quality businesses to chase short-term returns. He strongly prefers to hold the best quality businesses he can find at any given point in time.

MFF’s long-term performance is fair, but it lost around 3% (pre-tax) in the year to August, compared to the MSCI World Index’s gain of 1%, with its exposure to financial stocks weighing it down. At the end of August, the fund’s top five holdings were Visa, Home Depot, Lowe’s, Mastercard and Wells Fargo, which between them comprised half the portfolio’s value.

The stock currently trades at a discount of around 12% to its pre-tax NTA and close to par with its post-tax NTA, although these figures move to a discount of around 5% and a premium of around 9% respectively after accounting for option dilution. HOLD.

Thorney Opportunities (TOP)

Thorney Opportunities is similar to Bailador Technology Investments, not when it comes to the companies it invests in, but in the way it gives the everyday investor access to something they otherwise would not have and that is a well-regarded activist investor fighting to unlock value.

Thorney is managed by Alex Waislitz who is known for unlocking value in companies in a number of ways. The portfolio is incredibly concentrated with fewer than 10 holdings to its name. In the past year that handful of names has performed well. Among the stocks held are AMA Group, Service Stream and Diversa.

Two weeks ago I sat down with Waislitz and discussed other possible opportunities still within the portfolio. After the video Waislitz stuck around to discuss the outlook for the rest of the portfolio as well (click here to be see the video).

The stock currently trades at a discount of around 4% to its pre-tax NTA and a discount of half a percent post-tax. HOLD.

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