Taking stock of some core LICs

Reporting season allows us to revisit our managers and take stock.

Summary: With their focus on monthly net tangible assets updates, our LICs presented few surprises during reporting season.

Key take-out: Unlisted business investor Bailador is the current best value of our core LIC investments, with the remainder tracking steadily.

Key beneficiaries: General investors. Category: Listed Investment Companies.

Reporting season doesn’t mean too much for LIC investors as you can keep up to date on a monthly basis with the monthly net tangible assets (NTA) updates. For some, you can even keep up daily if you wanted to torture yourself. What reporting season does allow us to do is revisit our managers and take stock. Below are our thoughts on three core holdings in the LIC portfolio and one old favourite.

BKI Investment Company (BKI)

BKI is a true throwback to the LICs of the likes of Argo and AFIC. It’s an internally managed portfolio of high quality, dividend paying businesses and carries very little cash. Being internally managed there is a strong focus on keeping costs low. The team has a saying, “the thicker the carpet the thinner the dividend”. The lower the fees the more there is for shareholders (which management and the board are).

Coming out of the Brickworks portfolio, the BKI team have the benefit of sitting in the same office as Brickworks and Sol Patt’s, which house some of Australia’s best long-term investment minds.

The last 12 months have been challenging for BKI, as it has been for the market in general. Total shareholder return for the 12 months to June 30 was negative 0.8 per cent, underperforming the market which returned positive 0.9 per cent. The commentary coming from management was sedate and echoed the team's long-term steady approach. Management also acknowledged the excessively priced traditional income stocks and their cautious take on unsustainable dividends.

You know what you are getting from BKI: a steady stream of dividends from quality businesses at a cheap price. The management expense ratio (think fees) sits at 0.16 per cent per annum. This is cheaper than the majority of exchange traded funds out there.

Last reported post-tax net tangible assets was $1.54 and pre-tax was $1.64. With the share price sitting at $1.58 BKI is a Hold. Given the paper-thin expense ratio we do not require a deep discount to NTA to justify an investment but we would still like to see it below post-tax NTA. HOLD.

Bailador Technology Investments (BTI) 

Bailador is the opposite end of the spectrum to BKI and this is an example of what the LIC structure suits. The closed end nature is perfect to give investors the opportunity to invest in illiquid unlisted businesses. Bailador gives retail investors exposure to an asset class generally not accessible. 

Bailador specialises in investing in unlisted internet-based businesses. Its largest holding is the highly successful hotel rooms management system SiteMinder. It’s a subscription based, software-as-a-service business with high levels of recurring revenue. It has more than 400 distribution partners across 100 countries and equates for 24.6 per cent of Bailador’s portfolio.

Due to the lumpy nature of Bailador’s returns and the valuation of the underlying businesses a disconnect exists between the share price and value. Over the short term this is going to be even more predominant. Unlike listed equities where the market is constantly changing the price, the valuations in these businesses don’t change on a daily, weekly or monthly basis. For some investors the lack of change may prove to be frustrating and cause the LIC to trade at a discount to NTA for long periods of time. But remember the underlying value here needs to be taken with a grain of salt and is at best a measuring stick in which you need to see a substantial discount to value.

The 2016 financial year was a big year for the Bailador team bringing in a large chunk of funds from the exercising of options and putting it to work. Bailador is a small portion of the overall portfolio and something we are more than happy to put in the bottom drawer and watch as it plays out. We definitely look forward to the big sugar hits when profits are taken and dividends are paid.

Currently the Bailador share price is trading at a discount to post-tax NTA of approximately 4.5 per cent. BUY.

Magellan Flagship Fund (MFF)

Magellan Flagship Fund’s fortunes swayed in the wind with the rest of the global managers in FY16. Magellan Flagship Fund finished the year marginally down, in a month that wiped off any previous gains as it finished with the Brexit.

Throughout the year portfolio manager and managing director, Chris Mackay consistently wrote to shareholders in the monthly NTA updates of valuations being stretched in the quality businesses he was targeting for the portfolio. He also remained firm in not compromising the quality of his portfolio by going up the risk curve and investing in smaller and lower-quality businesses to chase returns. Since the pullback at the end of FY16, Mackay has seen opportunities become moderately priced again.

With total sales in the portfolio of approximately 1.5 per cent the Magellan Flagship portfolio is hardly something you would call reactionary. I urge you to read Mackay’s letter to shareholders in the annual report (click here to read) and to continue to follow his commentary in the LIC's monthly NTA announcements. If you do you will see he is an investor after our own hearts. The updates are constant reminders to investors of his focus on value and quality and an unwavering focus on the long term. This is why Magellan Flagship Fund is our preferred LIC for international exposure, but at the right price of course.

Currently the share price is trading in line with MFF's post-tax NTA of $1.789. But if you were to take into consideration the outstanding options (which are well in the money with a strike price of $0.9964) you need to reduce the NTA by 14.6 cents. Therefore, making it not cheap enough for us. HOLD.

Australian Foundation Investment Company (AFI)

Although not in the model portfolio AFIC, as the great grandfather of LICs, is a portfolio we keep a close eye on. As you could imagine, AFIC's fortunes followed the market's.

What caught the attention was an increase in AFIC’s weighting in small- and mid-capitalisation stocks, from 15 per cent to 22 per cent, since last year. When you’re managing a $6.4 billion portfolio and selling larger holdings is likely to incur tax costs, a 7 per cent shift is significant.

Management noted in its outlook statement that subdued returns were "likely for quite some time" and, to deliver reasonable growth, they clearly feel they need to take a broader approach. Given the outperformance of small and mid-caps over the past year and more, though, they may have missed the boat – or at least the best cabins.

What intrigues us most is not what AFIC is or isn't doing but what the second-largest LIC in the country, Argo, has decided to do. Following on from AFIC's result, Argo made specific mention in its annual report to staying the course with high-quality investments and not changing its investment approach. How the two portfolios fare over the course of the next year will be worth keeping an eye on.

AFIC is currently trading at a slender premium to pre-tax NTA and a larger premium to post tax. HOLD.


If you have any questions about the LIC Portfolio, or listed investment companies more generally, email letters@eurekareport.com.au and I will answer your queries in a regular Q&A style article.