Your most-asked LIC questions answered

Back in January, Eureka Report and brightday held a webcast answering questions submitted by subscribers about listed investment companies (LICs) (view on demand here). Well over a thousand people watched live. A lot of ground was covered and a lot of questions were asked that we were unable to answer due to time.

A number of these questions were highly relevant to anyone looking at investing in or currently invested in LICs. I thought were well worth sharing with all our members interested to know more about the LIC space - these are some of the most frequent queries from subscribers: 

Do you use pre or post tax NTA to assess against the share price to see if value exists in a buy for a LIC and do you also factor in the dilution effect of options value if quoted? E.g. MFF's weekly NTA update on the ASX announcements.

-Rick

Answer: There is no hard and fast answer to this. It depends on the individual LIC. When it comes to options and the dilution effect, yes you should take it into consideration. The good folk at MFF include this calculation for you – but only if the options are “in the money”. The options for MFF are definitely in the money so definitely should be taken into consideration. In a case like PAF where the options are exercisable at $1 and they expire on May 31 with the share price currently at $0.865, it is unlikely at this point they will come into play.

When it comes to assessing post or pre-tax NTA you need to think about the turnover in the portfolio. A portfolio like MLT or BKI I know they are long-term holders of businesses. In some cases, this means multiple decades. They manage positions with tax implications in mind and are unlikely to liquidate these positions, so I look at the pre-tax NTA. For portfolios that are turned over more, consider the post-tax NTA. Generally there is not a lot separating them, so for a long-term investor this shouldn't be too much of a factor if you are looking to hold for 10 years.

How do LICs structure their fees/cost to the investor?

-Bruce

Answer: Fee structures are an interesting topic. You have two camps here: There are the original LICs that aim to keep fees to an absolute minimum with no performance fees (think BKI, AFI, MLT, ARG etc.). Then there are the newer LICs, with managed fund-style fees. These are generally 1 per cent management fees or higher with performance fees on top if the portfolio exceeds its benchmark. The performance fees are anywhere between 10 - 20 per cent of the outperformance percentage.

I do not have a problem with fees. You get what you pay for. I have a problem with managers charging managed fund type fees and not delivering on performance and shareholder engagement. The fees should be used to cover the cost of running the portfolio, staff and services like marketing. Just because the cash is already locked in after the capital raising doesn't mean the marketing and communication to shareholders stops. Or at least, it shouldn't mean that.

Keep in mind when looking at the options of an ETF or an LIC like MLT, ARG, AFI that the fee structure on these older LICs is typically less than an ETF. AFI has a management fee of 0.16 per cent. I could only find one ETF that had a lower management fee than AFI.

What do you think of AMP China Capital Limited (AGF)? It is at a large discount to NTA?

-Jason

Answer: AMP China Capital Limited (AGF) is a tough one. Firstly, it is operating in a very immature market. Could you imagine how the managers felt when half the Chinese market went into a trading halt! There are a few issues with AGF and reasons why it is trading at such a significant discount. Firstly I think there is a lot of fear around China in general. Secondly, the portfolio, although getting returns for shareholders has never once beaten or even equalled its benchmark nor has it ever traded at a premium or close to NTA to my knowledge.

Then there is the shareholder activism that has taken place. A number of shareholders have been speaking out about all of the above issues, along with the fact AMP is the manager, is the largest shareholder and the board is 100 per cent AMP too. Late last year, an independent review took place.

This LIC is at a huge discount to NTA and if you believe in the China story than it does represent an opportunity. There is every chance investors can do very well out of this, however before I recommend it I would like to do some thorough investigation first. There is no need to rush into this one. 

A question regarding Clime Capital Limited (CAM) preference share and performance - is the high interest being paid on CAMPA stock the reason for the poor performance by the CAM LIC?

-Bruce

Answer: No. I believe the underlying poor portfolio performance and therefore the lack of confidence by investors is the reason for the overall disappointing total shareholder return.

The management team there are experienced and the investment team are sound and have been together for a number of years. In the last few years the mandate was also updated to include the ability to hold international shares. This has increased recently and the portfolio has also made use of a US dollar ETF as well. Right now there are a lot of good LICs out there with more coming. For investors to take note of CAM the team needs to start putting material runs on the board and then the investors will return and the gap will close. 

Could you please recommend some LICs?

Answer: Sure can. As a Eureka Report subscriber, you can get an article from me every week and also follow my model LIC portfolio. Read updates through the LIC portfolio page here.

Are international LICs a better option at the moment given the prospect of a fall in the Aussie? Platinum or Magellan?

-Vance

Answer: International LICs will play an important role in a diversified portfolio. The dollar has dropped considerably over the last two years and if you anticipate the dollar will fall further then yes, definitely have a look at the international LICs.

Also take into consideration a lot of the international LICs will manage currency exposure, and at the end of the day it will affect returns. Also, a number of international LICs have to manage exposure to many different currencies as well; especially the ones that are have come along recently focusing on Asian markets.

Currency aside, the Australian market only makes up 2 per cent of the global market. It is a bit of a generalisation, but if you look at the Australian market it is basically made up of four banks, two resource companies, a telco, and two retailers. By sticking just to Australia, investors are limiting themselves to a lot of potential growth opportunities and the opportunity to invest in some of the most dynamic businesses in the world.

Also keep in mind Australian focused LICs that have a mandate that allows international shares too. Some to take a look at there are Cadence Capital Limited (CDM), Perpetual Investment Company Limited (PIC), Clime Capital Limited (CAM), Australian Leaders Fund Limited (ALF) and the NAOS Absolute Opportunities Company (NAC).

WAM Capital Limited (WAM) and Cadence Capital Limited (CDM) also have good yield, about 6.5 per cent fully franked. A good reason to keep and hold I think.

-Sammy

Answer: Good yields are also an indicator of successful performance. How does a company pay dividends? By making a profit in its operations activity. A LIC's everyday business is investing and generating returns and they pay dividends out of retained realised profits. Have a look at the profit reserves in an LIC's half yearly report. This will show you how much they have in the bank to potentially pay dividends out of. Therefore they can smooth out the dividends and save some for a rainy day. Keep in mind the profit reserves can be made up of unrealised profits too and these can be washed away just as quickly as they can build up.

Which LICs pursue shorting as part of their strategy?

-Kel

Answer: The ones that immediately come to mind are Cadence Capital, Australian Leaders Fund, Watermark Market Neutral Fund, the NAOS Asset Management LICs, the PM Capital LICs and most recently the highly publicised Absolute Performance Equity Fund, which uses a pair trading strategy.

What LICs have skin in the game?

Answer: You will find the vast majority of portfolio managers, management teams and board members will have skin in the game and you can find out just how much by having a look at the annual reports. Make sure the amount is meaningful, and not a thousand or so as a token gesture.

Are there any LICs that actively use options? Buy puts, sell calls, etc.?

-Michael

Answer: The most well known advocate of using options as part of its main strategy would be Djerriwarrh Investments Limited (DJW) and it does this with the aim of generating enhanced income to pay out greater dividends to shareholders. Other LICs do use options as part of the investment strategy but you will not find many that use it as a main component. You will find even AFIC write covered call options from time to time.

Do any LICs make use of ETFs?

-Michael

Answer: Some LICs do, but they don't just use ETFs to get market exposure. Typically they will use ETFs that are sector specific to play out a theme. Right now I know the NAOS Asset Management LICs are short a US biotech ETF. I have also seen LICs use ETFs to get currency exposure, for example Clime Capital holds a $US ETF. Another ETF I have seen some use is the BetaShares Australian High Interest Cash ETF with the code AAA. It comes in handy instead of shopping around for the best rates, investors can use AAA which does it for them.

Does Gowing qualify as an LIC? As boring an investment as the clothing it once retailed, but a rock solid low return non-volatile share, the company is invested in shares and property, principally shopping centres. A notable feature is the apparently low management salaries and longevity of the executive.

Answer: Looking at last year's annual report from Gowing Brothers (GOW) rental income made up 91 per cent of revenue. 80 per cent of the other income came from property revaluations. I would suggest GOW needs to be viewed more as a REIT rather than an LIC. 

On the subject of stocks that look like they could be LICs, I would argue Washington H Soul Pattinson (SOL) should be viewed as an unofficial listed investment compan. Given its track record and investments in TPG, BKW, NHC combined with the unlisted holdings and the company's portfolio of listed Strategic Investments (11.4 per cent of SOL's total portfolio) it is worth a look for those interested in long-term investment portfolios.

I'd be interested to read your views on the Ellerston LICs – their Global Fund and their Asia Fund. After the Global Fund was floated it was trading consistently at a substantial premium to its underlying value, but since it also floated its Asia Fund both funds have traded consistently at a substantial discount.  Is there any good reason for these apparent anomalies? I'd value any insights that you might have on this please.

-Chris

I have looked into EAI (read here: Ellerston and Platinum's Asian expansion, August 19, 2015) but I have not looked into EGI too thoroughly, because as you mentioned for quite a while it traded at a premium.

I cannot see any real reason for the drop in share price below NTA. Perhaps market sentiment? That's fairly grim at the moment. Or perhaps investors were freeing up capital for other LIC IPOs, like the Absolute Equity Performance Fund. 

It's hard to find rhyme or reason sometimes. Yes the NTA has dropped recently but so to has the market. It could very well be an opportunity to get a good LIC cheap. But before I say that with certainty I would like to look into it more thoroughly first.