It is quite possible that discounts on LICs might continue to contract in 2021, mainly due to a lack of supply. It is therefore no surprise that I am not expecting a great deal of LIC IPO activity next year. There was controversy surrounding sales commissions and LIC IPOs that got plenty of attention in 2019. (This was after a flood of new issuance in the few years prior, with many poor performers). For this reason, I doubt whether financial planners and investors have great appetite yet to take the plunge into new closed end fund products.
What was driving ASX LIC discounts to narrow late in 2020?
- Lack of new issuance as I just discussed. The cynics might suggest some advisors will now not show the willingness to recommend new closed end funds going forward because commissions were banned in 2020.
- Not only does fewer IPOs reduce LIC supply that would otherwise be the case, existing LICs are ceasing in their original form. We have seen a pickup in them getting taken over, wound up, or converted to open ended funds. This is even further pressure on the diminishing supply of LICs.
- There could be a strong level of core demand out there for the closed end fund format that may even be increasing. One key aspect of this is the “dividend smoothing” feature of LICs. Investors are increasingly adopting more of the view that you can hardly earn anything at all in the way of income from fixed income or cash. Rightly or wrongly, LICs that are providing a few years of strong guidance surrounding a future fully franked income stream, are being seen as the next best alternatives.
Does that mean many ASX LICs are great buys in 2021?
No, not necessarily. My points above are just a potential slight bias to expect a bit of a tailwind to overall returns as the chances of the discounts on many LICs contracting are good. This is only a small part of the equation, as the movement in the underlying NTAs are likely far more important.
Also any reduction in some of the LIC discounts from here are not likely to be as meaningful for returns as recently seen. For instance, we have seen in many cases from shortly after the bear market in early 2020 some huge narrowing of discounts. In other words, has the easy money been made, yes.
The battle for franking. How you might take advantage of franking credits.
As I mentioned earlier, we have seen more consolidation within the LIC sector in 2020. WAM Capital Limited (ASX:WAM) have been busy targeting Concentrated Leaders Fund Ltd (ASX:CLF) and Contango Income Generator Ltd (ASX:CIE). The former had long sat on a large pile of franking credits. We also saw Global Value Fund Ltd (ASX:GVF) try to merge with Contrarian Value Fund Ltd (ASX:CVF). The fact that CVF was also sitting on a good amount of franking credits was part of the appeal to GVF. I think this is an interesting area to watch in trying to discover potential targets for acquirers. Sometimes I think the market can be slow to see the value in such large piles of franking credits sitting on the balance sheet. Even after deals have been announced the market can under appreciate the value.
WAM Capital Amaysim Takeover
Sunland Group Limited (ASX:SDG) and Amaysim Australia Ltd (ASX:AYS) might potentailly be examples of what I discussed above. They have continued to appreciate after their initial spikes on the news. They are not LICs by the way, but funnily enough WAM capital are so keen for that franking credit value they have made a proposal to Amaysim.
This battle for franking ties in with the point I made earlier about LICs wanting to provide some strong future guidance of fully franked dividends. This is a tool that is increasingly being used to narrow the discount to NTA. LICs believe they can appeal to investors who are frustrated by earning next to nothing on term deposits or fixed income. They are striving to paint a picture of a very safe future income stream. Anything that sells I guess.
I have touched on the topics of identifying “hidden value” on the ASX in previous blog posts such as here and here. They may be worth a look for newer readers of this blog if you are interested in such strategies.
When does the pipeline of ASX LIC IPOs improve?
Well I have hinted I do not think it is on the cards for 2021, how about 2022? Perhaps, but what will be the marketing channel used if they have lost the network of advisors and brokers willing to plug them? I am not sure I have the answer to this, perhaps it takes longer, and new product offerings continue to favour the open-ended structure.
However if LIC discounts do happen to contract further don’t write off just how alluring for fund managers it can be to still launch closed end funds. Perhaps their new selling channels eventually turn more to the likes of Livewire markets, Firstlinks and Switzer for distribution and awareness? If the ASX still allows 10-year Investment Management Agreements fund managers will still want to “lock in” AUM fee revenue for the long term. As I pointed out in my last discussion on IMA termination fees, you can see how the minute you get an ASX LIC off the ground, it can kind of be like receiving an instant gift for many millions of dollars. This is due to the difficulty of terminating any IMA.
Are ASX LIC IPOs worth it?
If you do get tempted by any slick marketing campaign of ASX LICs doing an IPO, might be worth checking out my blog post here; with the warning it is a bit cynical, but could save you some money.
AVOID THIS ASX LIC IPO! – Value Investing for a living
I would be interested what readers think here, do you see any prospects of LIC IPOs to come back in 2021, feel free to comment further down below.
Are share purchase plans (SPPs) good?
Also be on the lookout for existing LICs in 2021 to issue new shares as soon as they start trading at the NTA for a few minutes. The usual suspects will cite reasons such as increasing liquidity and awareness of the LIC, reducing the fixed costs as a percentage, and great new opportunities to invest the new money. In some cases these can be good reasons I will admit. In most cases I see though, these are often weak reasons they give. The reason you will not hear will be because it increases AUM fee revenue for the manager. I wish I could truly believe that LIC boards always have existing shareholders in mind when dishing out placements to new sophisticated and professional investors.
Good luck in 2021
As this is my last blog post for the year, I wish all the best for readers here for 2021! I hope it is a lot better than 2020!
Update Feb 10th 2021 – Additional commentary to above post as below issues are relevant to the topic above.
WAM Global ASX review
WAM Global shares (bonus options) (ASX:WGB)
I made a comment above in relation to ASX LIC SPPs “The usual suspects will cite reasons such as increasing liquidity and awareness of the LIC, reducing the fixed costs as a percentage, and great new opportunities to invest the new money.” I implied to show some healthy skepticism with this comment “The reason you will not hear will be because it increases AUM fee revenue for the manager.”
When seeing today that WAM Global were issuing “free” bonus options shares it reminded me of my above points on ASX LICs trying to raise capital.
I can’t obviously offer advice about what to do with your WAM Global shares but it poses some interesting questions.
The purpose of the bonus issue per the announcement was to “increase it’s relevance in the market, improve the prospect of broker and research coverage, and gain additional interest of financial planners”.
Do you think WAM Global is really lacking in the above?
Another reason is “to reduce the fixed expense ratio of the company”.
WAM Global currently is more than $500 million in size, do you think that poses problems for it’s fixed expense ratio?
Would becoming a much larger LIC potentially prevent it from getting set in great smaller opportunities, i.e. do they become less “nimble” with their trading in the future as a result?
Is potentially doubling the size of the supply of units bullish for the price of the asset I own?
Is it a good thing that the balance of profit reserves and franking credits now possibly get shared over a much larger number of shares issued?
If I don’t have the money or willingness to take up my bonus options, will I get a fair price if I have to sell them on market?
Investors who wanted to invest more in WAM Global, has there even been anything stopping them of late given a normal discount to NTA, is a bonus plan necessary?
The announcement mentions they are pleased with the investment performance they have delivered and therefore excited about growing the fund to benefit shareholders. Performance has roughly matched the index BEFORE fees, expenses and taxes. Given their large base fees charged, this means an underperformance to a basic global equities ETF. Is this the time to pat yourself on the back and expand?
Are their enough independent directors on the board with significant skin in the game?
How do ASX LIC bonus options work? How much could options potentially dilute the NTA of my shares?
Lastly here is a few links on the topic of LIC options from over the last 5 years or so.
Nothing ‘Free’ About LIC Options – Forager Funds
Are free LIC options too good to be true? – ETF WatchDo
LIC options provide investors with value? (firstlinks.com.au)
As always comments welcome! I think my thoughts are different to many on this LIC bonus options issue.
That is a nice article Steve, you know exactly what you are talking about as far as the ones i know.
Good Luck with TGG
Hi Steve, interesting insight. I myself have shifted lanes from camp LIC and am now focusing on the more efficient ETF structure, although I still do hold Milton corporation. I tended to just focus on the old school, low cost LICs (AFI, MLT, ARG, BKI) and not really into the more expensive ‘exotic’ ones youve mentioned. Ironically, the bigger the LICs become, the more likely they will be included as a very small % in the ETFs – unless I have my wires crossed? I never understood this cross ownership mechanic (such as two LICs owning 50% shares in each other) and how this is actually documented.
Hi CaptainFI,
As a general rule of thumb I consider the “old school” LICs probably the only ones that you can adopt a bit of a set and forget approach. Maybe even the Future Generation LICs but they are very different to the old school ones. Aside from those there about another 100 or so LICs out there and on average they will just show underperformance if held long term due to high fee structures. I usually only get interested as I take an active approach and occasionally some look appealing when the discount is nearer 20%.
Focusing on ETFs instead of the old LICs these days might make sense with some of the premiums I have noticed. Also I think when I last checked the performance of Argo, BKI and MLT didn’t look all that great, although AFIC was going ok I think.
In terms of LICs getting big enough to be included in ETFs I don’t think that is the case. I think from memory indices such as ASX200 and the like have a rule where LICs are excluded.
I am guessing your cross ownership question comes from me mentioning some of the takeovers above. It has been a bit of more of a feature in the last year or so. When a LIC hasn’t been performing so well and trading at a large discount, shareholders often want to exit but not sell at the discount. If the investment management agreement permits, that can lead to action where shareholders can instead vote for a wind up (need a 5% holder to call a meeting though) so they can get their money back at NTA. (e.g. CVF ASX recently). It might also encourage a LIC with a premium to NTA to takeover and merge the underperforming LIC into its own. This allows shareholders in the underperforming LIC to potentially sell their investment in the merged entity without a discount. Or continue in the LIC via the one that took them over. This dynamic has seen WAM ASX takeover some LICs lately for example CIE ASX & CLF ASX. WAM get a good return from profiting on such targets by eliminating the discount and also boost the size of their LIC.
Hope that makes some sense, if not let me know. If you prefer to stick to investments that ensure you get around index returns though such as AFIC or VAS ETF is not something that you need to worry or pay much attention to though. Thanks for reading and stopping by for a comment.
Cheers
Steve.
When I mentioned “usual suspects” of LICs raising capital in this blog post, let’s just say the likes of CAM & WQG have never been shy coming forward with a new issue of shares! They are just a couple of more examples already in 2021, I am sure we will see more. Love how when some do the bonus options issues they are described as “loyalty” and given to you as a reward for free. How lovely and generous they are!
When I see LICs raising capital I treat it as a market sell signal. CAM have a great record of issuing shares at cycle highs!
Good point Bruce maybe it is a signal. CAM certainly don’t miss opportunities to increase that share count. 17 years nearly of mediocre (is that being kind?) returns? Although they are skillful at not displaying such returns on any of their reporting, which likes to change it’s styles / strategies every year or two.