The LIC sector is a fascinating market to operate in. Sometimes IPOs are well supported and discounts to NTA narrow, and at other times (such as now) the overall sector feels soft and many listed investment companies (LICs) trade at greater than average discounts.
On top of the discount to NTA, there is the underlying complexity of the actual equities each LIC invests in to consider. The sector each LIC invests in most likely had a large impact on how they performed over the last 12 months. For the 12 months to December 2018, the performance for the ASX 200, ASX Small Ordinaries and ASX Emerging Companies Indices were -2.8%, -8.7% and -19.9% respectively. Small and micro-cap equities fell much harder in the last quarter of 2018 than large caps. This appeared to have little to do with company fundamentals or news flow, and more to do with a liquidity squeeze at the smaller end.
Currently, we believe we are seeing the best of both worlds in a number of LICs. The combination of greater than average discounts and better than average value in the underlying portfolios.
Current Market Observations
The larger and older traditional listed investment companies (LICs) are trading at premiums or smaller than average discounts to NTA (e.g. AFIC circa 5% premium and Argo circa 2% premium). Over the longer term, we believe these larger LIC investment portfolios will perform in line with the ASX 200 at best and that over time, the LICs themselves will trade very close to their NTA on average. An investor could add value by buying the larger LICs at discounts or when the large cap stocks they hold have underperformed. We wrote about this opportunity in May last year (see here). Right now, the opposite is true – you would be paying a premium for larger LICs in a market where we feel many small cap focused LICs are much better value. If you want index like returns, in our view you might be better to buy one of the larger ETFs than an LIC.
In contrast to their larger cousins, demand for the small to medium size LICs appears to have reduced dramatically in January and February. In addition, we believe that many LICs that invest in small cap equities have better value underlying portfolios, leading to opportunities in this sector.
We have been taking advantage of these opportunities in our Affluence LIC Fund over the past 6 weeks. At 30 September 2018, our cash balance in the fund was 24%, as tight discounts and expensive underlying portfolios meant we were struggling to find compelling opportunities. At early February 2019, our cash balance in the Fund is below 10% and we are currently holding a greater number of LICs in the portfolio than we ever have.
While the ASX 200 Index has recovered by 7.5% year to date, the micro-cap and smaller end of the ASX Small Ordinaries has continued to languish. While there is no ASX LIC index, our calculations show that the overall LIC market has delivered well below this level of performance. The result is some great quality managers, holding relatively better value portfolios, at greater than average discounts.
Our Affluence LIC Fund currently holds over 30 different listed investment companies (LICs), ranging from higher quality managers at average discounts to NTA, to secondary managers trading at larger than average discounts. We have outlined three of the most interesting opportunities below.
Spheria Emerging Companies (ASX: SEC)
Spheria Asset Management was founded by Marcus Burns and Matthew Booker. They previously worked together at Schroders, where they were responsible for a very impressive track record for the small company fund. This LIC invests in small cap equities (generally ex-ASX 100). They have a value style bias, with a strong focus on free cash flow. SEC has a $110 million market capitalisation and an excellent distribution capability through Pinnacle (part owner of Spheria).
Until recently this LIC has traded at a relatively small discount to NTA, however this has increased to around 15% currently. We often see LICs go through this post IPO slump in the 6-18 months after listing, and the shareholder register can change quite substantially during this period. Often, many of the investors who participated in the IPO tend not to be long term holders, especially if initial gains don’t come quickly.
There are currently very limited buyers for SEC, and we have taken this opportunity to build a position at what we believe to be a very attractive entry point. We believe Spheria is an excellent investment manager and that they can produce well above average returns over a three to five year period.
Thorney Opportunities (ASX: TOP) and Thorney Technologies (ASX: TEK)
We have held TOP for a long time, as we believe Thorney to be one of the better investment managers in the LIC sector, and it has been trading at an attractive discount for quite a while (above 15%). We have recently added TEK to the portfolio, as it has been trading at a 20% plus discount on a more reasonable value underlying portfolio. Both are both reasonably small LICs (TOP $132 million and TEK $55 million). They share a similar investment philosophy, but with TOP focussing on more traditional sectors and TEK focussing on technology related equities.
Since listing in January 2017, TEK has traded on average at around NTA, but averages can be deceiving. TEK traded at a 30% plus premium in late 2017 and has been at a 20% plus discount recently. TOP began trading in December 2013, and while the average discount to NTA has been around 7%, it has at times traded at NTA or better. The current discounts for TOP and TEK at 16% and 20% respectively in no way reflect the quality of the manager.
We believe it is likely the manager will generate very good returns from the underlying portfolios, which can result in a significant tightening of the current discounts to NTA over time. If this occurs, there will be a substantial increase in the share price over time.
Before you rush out to buy these two though, there are a couple of things you should know. Both these LICs hold quite concentrated portfolios, which can make NTA’s more volatile. They also have very expensive fee structures, which the manager would be wise to revisit as they are well out of line with current averages. If you’re allergic to high fees, you won’t like these two.
Antipodes Global Investment (ASX: APL)
APL operates a global long short strategy, with the manager describing themselves as “pragmatic value”. Another LIC in the Pinnacle stable, APL was listed in October 2016 and traded around NTA for the first 18 months. As the option expiry date approached in October 2018 (2 years from IPO), the dilution from the option exercise started to become more of a factor. Most of the options were exercised by October 2018, diluting the NTA and putting pressure on the share price. This occurred at the same time as equity markets were falling in the last quarter of 2018.
As an investment manager, we believe Antipodes are of a similar or better quality to other similar LIC managers including Platinum, Magellan and PM Capital. APL is currently trading at an approximate 7.5% discount to NTA, which in some cases is significantly larger than its peers.
There are always risks in investing but buying cheaper than average is a great way to reduce them. We believe now is an excellent time to be deploying some cash into the sector, while demand is soft and we’re seeing limited bids on the buy-side. While we wouldn’t class LICs as extremely cheap, there’s a wide range priced at good discounts, with some value in underlying portfolios.
Before you invest, read this!
We encourage you to do your own research before investing in any LIC. Remember, a great LIC and a great manager is only part of the story. We also like to make sure they’re trading at the right price and that the assets they are investing in are not themselves overvalued.
A good starting point for education and ideas might be ASX’s investment products monthly report. There are also various LIC research reports available through Livewire Markets and brokers.
We explain how we do this in our LIC Guide, but in the end it’s up to you to make the investment decision that’s right for you, in conjunction with your financial advisor if you have one.
Take care and all the best with your investing.
Disclaimer: This article has been prepared by Affluence Funds Management Limited ABN 68 604 406 297 AFS Licence no. 475940 (Affluence) to enable investors in Affluence Funds to understand the underlying investments of the funds in more detail. It is not an investment recommendation. Prospective investors are not to construe the contents of this article as tax, legal or investment advice. Neither the information nor any opinion expressed constitutes an offer by Affluence, its subsidiaries, associates or any of their respective officers, employees, agents or advisers to buy or sell any financial products nor the provision of any financial product advice or service. The content does not consider your objectives, financial situation or needs. In deciding whether to acquire or continue to hold an investment in any financial product, you should consider the relevant disclosure documents for that product which are available from the product provider. Affluence recommends you consult your professional adviser to determine whether a financial product meets your objectives, financial situation or needs before making any decision to invest.