PM Capital backs foreign banks
Recommendation
With the decline in both the Australian dollar and sharemarket recently, investing overseas is gaining in popularity. As long-time members will recall, we've been banging this drum for years, but it still isn't too late.
As John Addis noted in that article, one way to do it is through internationally-focused listed investment companies (LICs) such as Magellan Flagship Fund, Hunter Hall Global Value Fund, Platinum Capital and Templeton Global Growth Fund.
Despite recent market falls, however, none of these LICs yet offer a sufficient discount to their asset values to warrant an upgrade (although Templeton Global Growth Fund is close). We'll keep monitoring them in the hope that they do become cheap enough but for now let's look at another international LIC that is already looking attractive.
Key Points
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LICs a good way to obtain international exposure
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Despite market falls, most not cheap enough...
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...but one added to Buy list
Global Opportunities Fund
After 14 successful years at Bankers Trust Australia, Paul Moore founded PM Capital in 1998 and his original fund – the Global Companies Fund – has beaten its benchmark (the MSCI World Index in Australian dollars) by 5.1% a year since then. Three more managed funds have followed – the Australian Companies Fund, the Asian Companies Fund and the Enhanced Yield Fund – and they too have comfortably beaten their benchmarks. PM Capital now boasts $2.2bn in funds under management.
Like many other fund managers, PM Capital recently extended its offering to LICs, launching PM Capital Global Opportunities Fund (PGF), an internationally-focused LIC, in December 2013 (see Table 1).
Share price | $0.91 |
Pre-tax NTA (at 8 Jan 16) | $1.11 |
Post-tax NTA (at 8 Jan 16) | $1.08 |
Discount to post-tax NTA | 16% |
Management fee | 1% per year |
Performance fee | 15% of return above MSCI World Index (AUD) |
PGF follows PM Capital's value investing philosophy that 'the best way to preserve and enhance your wealth is to buy a good business at a good price'. Its strategy is to invest in a concentrated portfolio of global shares (including Australian shares) and other securities, aiming to hold a total of about 40 stocks, with no one position exceeding 10% of the portfolio.
This concentrated strategy differs from the more diversified portfolios of many LICs and we see that as one of its attractions. If you're backing a manager to look after your money you want them to back themselves, although it does increase the risks, particularly since much of the concentration at the moment is in financials, as we'll see shortly.
The LIC can also use borrowings, short sales or derivatives to leverage the portfolio, up to a limit of 30% of its net asset value. 84% of PGF's currency exposure is to the US dollar and it will hedge against increases in the Australian dollar should it believe it necessary.
Fee-adjusted NTA
As we've noted before, we recommend purchasing LICs at a discount to their post-tax NTA, which reduces pre-tax NTA for tax payable on both realised and unrealised gains. This is to compensate investors for the ongoing costs of managing the LIC, which mean investors' returns over time will be less than those of the LIC's portfolio.
At current prices, investors can purchase PGF at a 16% discount to its most recently released post-tax NTA, which more than compensates for the 1% management fee and other ongoing costs. The consistent discount in recent months is no doubt a major reason why Paul Moore has been buying more shares and he now owns 7.3% of the LIC himself.
The LIC's portfolio itself doesn't look expensive, although it is heavily weighted to financials, as you can see from Table 2, which details PGF's top ten positions at 31 December, along with some simple valuation metrics.
Position | Fwd PER | P/TBV | FCF yield |
Alphabet (FKA Google) | 23 | nm | 3% |
Lloyds Banking Group | 9 | 0.9 | n/a |
Intercontinental Exchange | 19 | nm | 4% |
ING Groep | 10 | 1.0 | n/a |
Bank of America | 11 | 1.0 | n/a |
JP Morgan Chase | 10 | 1.3 | n/a |
Bank of Ireland | 12 | 1.1 | n/a |
Pfizer | 13 | nm | 7% |
Barclays | 8 | 0.7 | n/a |
Realogy | 18 | nm | 10% |
Source: S&P Capiq |
As you can see, financials made up 49% of the portfolio at that date. This is based on the manager's view that interest rates will rise in coming years and that this, along with credit growth, should help banks in the US, UK and Europe improve their earnings, book value and dividends. Even better, these banks are currently much more reasonably priced than their Australian equivalents such as Commonwealth Bank.
Services – which includes Alphabet (FKA Google) and ICE – the owner of the New York Stock Exchange – make up 22% of the portfolio, while 19% is invested in companies exposed to anticipated improvements in American residential property and European commercial property.
Capital growth
As a result of this concentrated portfolio and its emphasis on long-term capital growth rather than dividends, PM Capital recommends investors have a minimum timeframe of seven years. PGF intends to announce its inaugural dividend along with its upcoming 2016 first half result and, while it's unlikely to become a yield stock any time soon, dividends will be franked 'to the greatest extent possible'.
This may help close the discount between PGF's post-tax NTA and its share price, although there is no guarantee this will occur. To help in this regard, PM Capital is attempting to increase investors' familiarity with PGF and, if the substantial discount persists, it will also consider share buybacks.
More important, though, will be whether PM Capital can continue to buy undervalued stocks and help PGF outperform its benchmark, as it has in the past. We think it can and, with the margin of safety provided by the substantial discount, we're upgrading PGF to Buy, with a maximum recommended portfolio weighting of 5%. Note though that with LICs the level of the discount matters, and we wouldn't advise chasing it below a 10% discount to NTA, which amounts to a Buy price of about $0.95. BUY.
Note: since its underlying value changes every day with the market, we're not going to put a price guide on PGF.