Taking a break from Cadence Capital

Our LICs have beaten the market since the portfolio's inception – here are our plans going forward.

We’ve come to the end of the first quarter for the calendar year and it’s time to sit back and take stock of the LIC portfolio. The All Ordinaries Accumulation Index declined -2.35 per cent for the quarter. The LIC model portfolio was down -3.79 per cent.

Since inception, the LIC portfolio is up 2.69 per cent while the All Ords is down -2.4 per cent.

The portfolio performance has been reasonable given that it is very close to fully invested in a time of high volatility. The effects of that market volatility is known only after the LICs release NTA updates, so they tend to have a delayed reaction to market movements.

The first sell call

The major headache right now for the portfolio is Cadence Capital Limited (CDM). CDM has a long term track record of performance. Over the last ten years the total shareholder return has been 11.33 per cent pa, significantly outperforming the All Ords Accumulation Index by 7.29 per cent pa. That’s good going. However, CDM has been pushing the upper limits of what we are comfortable with when it comes to trading at a premium to the LIC’s net tangible assets (NTA).

Despite the underlying NTA slipping away, the share price has held up under pressure and creating a further disconnect. What I believe is holding the share price up is the anticipation of the dividend. On April 27, CDM will pay a fully franked 5-cent dividend. That is a further 5 cents that will come out of the NTA, which will be adjusted for the DRP take up.

Once the dividend is paid I would anticipate the share price to more closely reflect the NTA. What the LIC model portfolio is not willing to do is hold an overvalued position and have capital at risk just for a dividend. As investors, it is important we think of total return. At the time of writing CDM was trading at a 23 per cent premium to NTA. A 7.6 per cent dividend yield (10.9 per cent grossed up) is not adequate compensation for the risk of the share price realigning with NTA. This is why the LIC model portfolio is selling CDM. The decision is based purely on the growing disconnect between share price and underlying portfolio value. The decision has nothing to do with the portfolio manager's performance, and the LIC model portfolio will look to return to CDM at a more opportune time.

What are we going to do with the cash? Nothing for now. It’s a long game and we are patient investors. The watchlist will be consulted and next week we will walk through the stocks we are keeping a very close eye on.

Code

P/D to NTA

BKI

13.10 per cent

CDM

23.08 per cent

MFF

6.70 per cent

PAF

-12.12 per cent

PIC

-6.06 per cent

TOP

-1.85 per cent

WAX

13.68 per cent

Looking at the rest of the portfolio we will be keeping an eye on WAX and BKI. Both are trading at an increasing premium when compared to the value of the underlying assets in the portfolios. Because of this premium, WAX and BKI are holds for the model portfolio.


Speaking of the Geoff Wilson managed WAX, it has continued to be the standout performer in the model portfolio. In general the small to mid cap index end of the market has outperformed the larger end of town. When you combine this sector performance with the careful stock picking of the WAX team it is easy to see why it has outperformed in the portfolio.  

The biggest detractor from the portfolio performance for the quarter was Magellan Flagship Fund. This position was down 12 per cent for the quarter. It serves as a reminder that investing is a long term pursuit and looking at returns on a quarter by quarter basis is not the real measure of a portfolio. Since inception this position is actually up 4.3 per cent.

Given the discounts still available in PIC, TOP and PAF the buy calls remain.


And of course Cadence is a sell for now. Over the years I have heard investors constantly use the excuse “but it pays a good dividend” to justify a holding. As long term investors we need to always have total return in the forefront of our mind. What is the use of 6 per cent dividend if your capital declines by 20 per cent? Capital preservation plays just as greater role as capital appreciation in a portfolio.

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