TIME FOR GLOBAL ACTIVE MANAGERS TO OUTPERFORM & COMMON CATALYSTS FOR LICs.

Most investors probably have an inkling that active fund managers are not doing a stellar job when it comes to outperforming the S&P 500 of late. Sometimes a chart is worth a thousand words, and the above one ought to grab the attention of those with a penchant towards a mean reversion, contrarian and cyclical approach to their investing.

This post will predominately be for those that subscribe to the theory that active managers may be in store for some sort of return to favor over the next few years, and potential implications of this for some LICs.

One theme that surprised me over the last couple of years was the lacklustre rating of some high profile actively managed international LICs, that have clearly proved themselves as being able to outperform over long periods. I place PM Capital & Ellerston Capital in this category. Both had proved themselves as good active managers over long periods, prior to establishing LICs a few years ago. PM Capital have a global LIC (PGF) and an Asia focused LIC (PAF), and the same applies to Ellerston Capital with EGI & EAI respectively. Over the last couple of years, they have all traded at substantial discounts to NTA. If one purely judged them on relative performance during their lives as LICs, perhaps this made some sense. The market seemingly placed very little emphasis that these asset management teams have delivered good results going back now to 15-20-year records in some cases.

The opportunity to buy at a very large discount to NTA may have diminished somewhat this year, but I still find it interesting that the market places a larger discount to them compared with many Australian focused LICs. I fully understand their fee structures may be more expensive in some cases, but at the end of the day it is the after fees and taxes return that you have in your pocket. On that front, the returns from PM Capital & Ellerston (assuming we combine their unlisted performance records spanning many years) come out quite attractive.

PM Capital’s long running global product since 1998 has solid absolute returns, despite arguably commencing with headwinds such as expensive US valuations and an Australian dollar in the low 60s. Both these fund manager’s long term unlisted records look even more impressive relative to benchmarks. I concede that the Ellerston LICs don’t have as much of a resemblance to their unlisted products like is the case with PM Capital. They do however draw on many of the proven strengths shown by their investment team over a long period of time.

Another one I could make the same point with is Platinum Asia (PAI). This has often traded at an attractive discount to NTA, strangely even when the Platinum International Fund (PMC) has commanded a premium. Whilst the individual portfolio managers may differ between the two, Platinum Asia has a very good track record when going back and looking at their unlisted product over the long term. If the market’s differing ratings of the Platinum LICs comes down to concern over the Asian region, this would be a little strange given PMC has a large active bet to this region anyway.

COMMON LIC CATALYSTS.

This leads me to another observation in the LIC space, where a couple of catalysts often lead to a positive short-term re-rating in the share price. There is nothing groundbreakingly new in me mentioning options expiry and dividends as two potential catalysts, but I thought I would relate it back to some examples with actively managed LICs of late.

I purchased some PAI shares in May this year for $1, which coincided with the expiry of the associated listed options. I estimated they were trading at greater than a 10% discount to NTA. Interestingly, only a month or so later, the NTA had weakened yet the shares had climbed to $1.07. Another small part of the reasons for buying was also that I expected them to announce their first dividend soon. On some occasions, simply reading through the historical financial reports about matters such as dividend policy, profit reserves, franking credit balances and noting how the underlying portfolio is currently tracking can provide you with a very good guide as to the upcoming dividend. I find that announcing the very first dividend, or a large increase in dividend can provide a short-term boost to the share price.

Another example that springs to mind that I have blogged about in the past is Sandon Capital (SNC). In the second half of 2016 it was evident that the portfolio was performing well, they had plenty of franking credits on hand, and a strong dividend policy. The semi-annual dividend climbing from the 2-cent range to 3-3.5 cent mark personally did not surprise me given their communications. What did surprise me was the share price going from a 15% discount to NTA to a 5% premium. The positive re-rating seemed to gain extra legs around these dividend announcements.

COMBINING THE ABOVE OBSERVATIONS

The above themes have been playing on my mind and in part led me to buy the Future Generation Global Fund (FGG) recently. Ahead of it in the shorter term is the options expiry and hopefully a dividend is not too far away. It is a fund of funds approach with a very high-quality list of active managers on board. I like the concept of seeing some money go to charitable causes rather than the fund managers directly. From purely investment considerations though, taking a view that the better active fund managers are likely to be heading for a cyclical period where they may substantially outperform their benchmarks appeals. What also appeals to me is I gain this exposure far cheaper than if I was to try to access these fund managers directly, and if they shoot the lights out my returns will not get deflated from fat performance fees.

In recent times, I had written about comparing many of the Wilson Asset Management LICs. Last year Century Australia (CYA) appealed to me, and this year I felt the new WAM Microcap (WMI) made sense at the IPO price. I realise FGG is not directly managed by the Wilson team, but it was founded by Geoff Wilson. If I had to pick amongst all the Wilson LICs and Future Generation then I would favour FGG from this point, especially at about a 5% discount to NTA where it is at the time of writing and under $1.10 where Geoff has been buying heavily. Any additional weakness occurring in the last month before options expiry may prove to be a timely entry. In that event I would expect the removal of the options overhang to eventually lead to some recovery in the following months, like was witnessed in the PAI example. If my opinion doesn’t amount to much for you, it may be of interest to note the following ASX announcement provided by Geoff Wilson.

http://futuregeninvest.com.au/wp-content/uploads/2017/07/Geoff-Wilson-Why-I-have-been-buying-FGG-shares.pdf

Perhaps it is time to at least check up on how much exposure your portfolio has in Australia’s relatively concentrated index. From a currency perspective at least, it may be a better time to do so than compared with a few months ago.

In the cases above the fees you pay will undoubtedly not be the cheapest around. But like most things in life, obtaining the lowest fee products is not certain to offer you the greatest value for money. Because we are in the mature stages of a bull market, I must admit I am not supremely confident of the absolute returns some of these funds can generate going forward in the shorter term. My confidence is high though that the likes of PM Capital, Ellerston, Platinum and the Future Generation Funds can outperform their benchmarks in the medium to longer term from today’s levels.

For disclosure purposes, I should note that at the time of writing I own shares in EAI, FGG & PAI, of those mentioned above.

15 thoughts on “TIME FOR GLOBAL ACTIVE MANAGERS TO OUTPERFORM & COMMON CATALYSTS FOR LICs.”

  1. Hi Steve,

    Great stuff as usual. Always a great read.

    As you know I’m a long term lazy investor. Although I think passive Cap Weighted index ETFs make a great core holding, unlike others I haven’t given up on active Mgrs. I could pick and choose individual Global Mgrs but as usual I take the easiest path and hence hold FGG. This gives us wide diversification of top line Mgrs without the high fee drag. I’ve progressively built up my holding in FGG with an average price around $1.05. With options expiry in September I’m hoping like you stated that a recovery will occur. An announcement of a reasonable dividend on top of this could see a significant boost to price. It’s a long term focus for us.

    For a long term near set and forget investor I think a simple combination of VGS and FGG ain’t all that bad an option in terms of covering most bases.

    Our only other Global LIC purchased cheaply over a very long time period is PMC. They certainly haven’t shot the lights out performance wise for quite some time. But PMC gives us an Asian tilt without having to commit to a dedicated Asian mandated LIC which carries higher risk.

    As I said earlier being lazy our Global portfolio is hardly the result of skilful analysis. Plus it’s simple, low maintenance, gives us great diversification to offset home country risk and heavy concentration of the ASX plus lets us sleep well at night.

    End of ramble:-)

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    1. Thanks Austing I think you have a good approach there. Whilst it may sound like I am sticking up for the active fund managers, I do agree with the consensus that for most people most of the time, just keeping your fees low should be the goal. As a general rule active managers are overpaid.

      I just found it interesting lately a recent Contango global product was trading at a premium, and a bit of hype on the new VGI float. Some of the ones I mention here have better fee structures, a good record and at discounts. Maybe it is a mug’s game picking managers, but some of those mentioned in my post have long records, perhaps lucky over ten or twenty years? Doubt Paul Moore, Ashok Jacob & Kerr Neilson are about to do a runner but now I say that they will probably do a Peter Hall tomorrow!

      To be honest with FGG I hope for some weakness in the next month to increase my holding. It is as you say a good product for a lazy investor. Interestingly I think it has VGI as one of their managers.

      I wonder where FGG shares would be if they got lucky with timing their float to get the tailwind of the falling AUD from nearer parity. GVF provides a good unique offshore exposure, diversified with lower risk, but with a very high fee structure. Yet it always trades at a premium. It has been managed very well but certainly floating it when the AUD was very high was handy.

      End of my ramble! 🙂

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  2. Hi Steve,

    Thank you for the insights. Agree with your analysis. I’m a big fan of LICs and active managers. I invest in FGG, MHG, PGF etc. It always puzzles me why some funds trade at a large discount to NTA while performing well whereas others persistently trade at a premium with average returns. I thought good marketing may have played some roles. It’s obviously more to it.

    Another manager I invest with is Watermark. Their three LICs – ALF, WMK, WGF – are all under heavy selling at the moment with NTA declining a bit, particularly ALF. They must have got some trades wrong. I think you might have commented a bit about the long/short strategy in the past. Do you think Watermark is a quality manager? I thought the strategy should work well in a volatile market ahead, provided the manager knows what they’re doing. Thank you. Sara

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    1. Hi Sara,

      I think Justin Braitling is a good operator with those you mentioned. In short, I just think the fee structure is too expensive, WMK performance fee 20% above RBA rate from memory. Think about how much fees get leaked out if you are with them and they grow the portfolio by 20% one year, of course if the lose 20% you cop it all and then some. I am not sure of the ALF fee, but shares have suffered the extra hit from the premium to NTA vanishing.

      Steve.

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  3. Steve, a few comments:-

    1. The Platinum International Fund is unlisted so cannot trade at a premium or discount. The listed fund PMC is Platinum Capital, which I’ve no doubt is the one you meant.

    2. Probably worth mentioning that SNC, who’s listing options expired worthless, issued another batch with a strike price of $1-05. I was not impressed. They expire on 30/4/18.

    3. FGG paid its maiden dividend of 1c on 31/10/16. I think I recall that like many international funds, it will only pay final dividends, so expect the next one at the end of October.

    On a more general note, I have a bit of a problem with fund managers buying shares close to option expiry. While not doubting for a moment Geoff Wilson’s integrity, I have suspicions that the main aim of some of the smaller LIC managers buying shares is to keep the options in the money. Dare I say the more options exercised the higher the management fees. Admittedly some of these managers are probably doing it hard with their current funds under management.

    In response to Sara, it should be noted that a few years back ALF was trading at a large premium to NTA, seemingly ignoring the dilution affect of the options. I was able to sell the options at 35c. From memory they eventually expired worthless. Over time, probably helped by a continually reduction in the dividend, the shares have come back to match the NTA ratio of around 1 for the newer WMK.

    Disclosure. I have holdings in the five LICs I have mentioned.

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    1. Hi Graeme,

      Yes I probably should have called it Platinum Capital, but referring to PMC as you said at a premium.

      Totally agree with you on SNC. Although I sold virtually all of mine not long before this was announced, I was a bit surprised and disappointed they went down that path.

      Correct with the dividend for FGG. Will not be the first but maybe a little more and attract some attention given it hasn’t paid out much yet. I also understand where you are coming from about the managers buying shares before options expiry. I have no doubt there would have been cases where the motives are questionable. I think with FGG though it is a bit different in the sense that further options being exercised will benefit the charities.

      Great point about your experience with options in ALF. Sometimes I look at the pricing of LIC options and I also wonder if investors forget about potential dilution. I find it hard to find cheap LIC options.

      Cheers
      Steve.

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  4. Hi Steve – I like the blog, please keep it going. I have some comments and questions about some of the LICs you’ve mentioned. I’ve been a holder of both Future Gen funds (FGX & FGG) and currently hold FGG. I’m not sure what to make of these now. The theory seems really solid – a spread of top tier fund managers and a 1% fee (donation) but the performance has been underwhelming. You could say that the performance of both has been poor.
    I think I’ve got this correct – FGX listed in Sept 2014 at $1.10 and almost 3 years later the price is $1.10 and the NTA is $1.15. I think they’ve paid dividends of around 4% p.a.
    FGG listed in Aug 2015 at $1.10 and are now $1.095 with an NTA of $1.13 and I assume have also paid dividends. I can see the argument about FGG rising from here because of option expiry and a potential fall in the $A, although FGX has no option overhang and trades at a similar discount to NTA.
    I’m not writing this to bag these funds, I really like the concept and the investment thesis stacks up. I want to be a believer but so far it looks, on face value, like they’ve under-performed and in the case of FGG it’s been thru a period of a strong US market. What are your thoughts, is it the rise in the $A that’s beaten up FGG and we’ll benefit when it pulls back or is the strong performance of some of the funds dragged down by weakness in other funds? Cheers..

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    1. Hi Noddy,

      I can understand that holding the future gen funds has not been very exciting during this bull market. Actually FGG has only paid a one cent dividend so it is worse than you suggested!

      FGG in absolute terms has been held back recently by a rising AUD. I don’t want to get into debates about predicting currencies. I’d just point out that there are probably reasons for Australian investors to want to get some exposure to a falling AUD eg IF the Australian economy worsened, how exposed are many via their job or property exposures, a diversifier may be handy?

      As far as the underlying funds performing or not, that also hasn’t been very exciting. I just see it as a very short time in markets to draw conclusions from. When I looked individually into the funds involved, I noticed clear evidence of alpha generated after fees going back to pre GFC or longer in most cases.

      That’s where I take it back to the graph at the start of the post. I see the market moving in cycles and perhaps now we are at a far less extreme of how the markets looked in 1999. Back then managers that avoided “new economy” stocks were ridiculed and performance looked terrible. The US the market has been led by a relatively narrow group of names, probably exacerbated by inflows into major ETFs from the love of passive investing right now. Many considered it foolish trying to pick managers to beat the index in 1999, but any half decent manager at the time should have outperformed over the following decade.

      I just think the market is testing our patience with value investing. Tests mine at times. Appreciate your kind words on the blog but it is funny to think at times I could have just mentioned one trade on the blog, own a passive fund tracking the S&P 500. I’d have to check, but that may have beaten my returns since blogging!

      If I had of made the blog about cryptocurrencies I would have a huge audience! I have spent quite a few months in Chiang Mai, Thailand the last couple of years and plenty think trading Bitcoin is the answer to becoming a “digital nomad”. All after being frustrated with the 9-5 office grind after doing the hard life between the ages of 21 to 23. Using Robo-Advisors is all the rage too, which mostly focus on ETFs as I understand. Don’t really have a problem with Robo-Advisors but also highlights the negativity to active managers right now and the faith that getting results should be simple, part of which I believe is cyclical as the initial chart may indicate.

      That doesn’t mean any active managers are the way to go of course, but I think there are at least a small number out there that have long enough track records to warrant some serious consideration.

      Steve.

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      1. Thanks Steve – that’s a good summary and I have read elsewhere about the impact of the huge inflows into ETFs driving up the biggest US stocks and the potential for that to get messy if/when things reverse. FWIW my investments are in direct shares, managed funds, hedge funds and LICs. If I gave up on FGG, I would most likely move that capital into another fund not an ETF. The whole ETF – investing in indexes thing hasn’t appealed to me.

        I have previously been totally in direct shares for many years – I now think that I was probably buying too much into the constant messaging about the average managed fund failing to beat the market. My thinking was that I didn’t want to pay fees for someone to under-perform for me. Now, I think that was simplistic. I’ve thought more now about absolute performance funds vs big index huggers and looked into it further and can see that there are fund managers that have performed above the market for a long time, net of fees.

        I’d be interested in any thoughts you have on different LIC options strategies. In one of your other posts I think there was a mention of Antipodes (APL). I have bought APL options that expire Oct 2018. The current share price is $1.20, NTA is $1.18 and the options are about 10c. They floated at $1.10 in Oct 2016, so assuming that the starting NTA was a few cents off the $1.10 then they’ve added about 10% and it’s a global fund so the falling $A would’ve been a headwind. I’ve bought these with a view to converting them all as they approach expiry. I’m at a stage where I’m maximising contributions into my SMSF so I see this as a way of putting a deposit down on a fund that I like and if they keep rolling along then I get 14 months of potential growth and then pay for the rest of it with some of next year’s SMSF contributions. Of course, it could go also backwards and the options get wiped out and I’ve done my dough. (I understand about the option overhang impacting share price until then and of course I would’ve been better of buying into the IPO at the time getting the options free). Anyway, a lot of people seem to see LIC options as a gimmick or a pain in the a… but it seems to me that there’s also potential to gain from inefficiencies or mismatches and as I think you mentioned somewhere, possibly benefit from holders that don’t appreciate them or understand them and get rid of them at the wrong time. Cheers..

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      2. Yes I have mentioned a few potential active managers to consider but there are tons and tons of rubbish “active” managers out there both here and in the US. Collecting perhaps a percent or more in fees, hugging the index, underperforming, possibly full of lazy money from super contributions via platforms that the individual doesn’t pay any attention to. ETFs are a great alternative to these but not the answer for everything. Going passive still requires the active decision of which market? There are examples of single countries having drawdowns of 80-100% historically so staying the course is not always easy.

        With regards to LIC options I haven’t looked closely into the APL situation. I am also trying to move away a bit from blogging about illiquid areas. Usually LIC options are in that category. There are a lot of dodgy operators on the forums and twitter so don’t want to get near that. I would just stress to calculate carefully the potential dilution that can occur to the NTA. It can be a complicated area with many factors impacting where the shares end up at around expiry. Read the comment from Graeme on this thread I think about his experience with ALF options, sometimes the market can get carried away.

        I have only ever purchased LIC options in one case so still an area I am learning and watching about, so can’t speak of success stories here. I’m curious about the area because so many small investors may have received them for the first time in recent floats, and could have the potential to sell without thinking about their value too much. I couldn’t yet offer examples though.

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  5. On the subject of FGX / FGG one of my concerns has been that Fund Mgr participation is voluntary. Lets hope that that good Mgrs will always be generous enough to participate. However I’m reasonably confident there will always be enough quality Mgrs willing to volunteer their services given that philanthropy seems strong in this area.

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    1. Good question and I also would be interested to know. From memory I don’t think they give a detailed look through breakdown? Perhaps it is even not a strong focus internally, the investment committee may not see that as an area for them to add value at the top down level? I don’t think the underlying funds generally hedge back to AUD though.

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      1. From FGG prospectus:
        “Foreign Exchange Risk
        … The Company has no current intention to ofset this risk by entering into hedging contracts or leverage its investments to increase returns.”

        But some of the portfolio’s funds may manage currency. For example the Mgr (Antipodies – ex Platinum staff) featured in July NTA report does manage currency from memory. As Steve stated I don’t think the Investment Committee provide a detailed breakdown of any currency managment by the portfolio’s funds.

        However looking at FGG’s recent results the Investment Committee look like they might include / exclude funds based on their view of the AU$. Refer p1 of following Report (Operating and Financial Review). Note comment on Asia and $AU resulting in Asian funds being removed from portfolio. It’s a little unclear though:

        http://www.asx.com.au/asxpdf/20170829/pdf/43lv3tty04drlj.pdf

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