A good reminder on some themes to consider in LIC’s over the next year.

I realise many of the readers here may already have come across this article from Daryl Wilson at Affluence Funds Management but felt it was worth a mention. I tend to agree with many of their views in articles I come across and this was no exception.  I thought I would just comment further down about how some of the themes they brought up in the article may be impacting my own decision making.

It’s been a while since I have discussed some of my specific investments. Partially as I have found it hard to get excited about new purchases, and partially because my portfolio has been quite disappointing in recent months! Here is the latest article from Affluence Funds Management.

https://www.livewiremarkets.com/wires/avoiding-the-great-labor-franking-credit-grab

The first thing I wish to note is I have sold the majority of my holding in PAI when it has traded above $1.30 of late. The above article discusses to be careful of premiums and some of my sales were at an estimated premium of 7% to before tax NTA, or about 11% to post tax NTA. That is a far cry from only about 12 months ago of a discount to pre tax NTA of 10%. It is approaching a premium to NTA where if it expands further a SPP wouldn’t surprise me. In that case I could perhaps replace a decent chunk of what I have sold via any such plan if it was announced anyway. When selling stock in such an example I often leave residual holdings in different account type structures in case of such a chance.

PAI is a well-run LIC so I could understand many investors hanging on to everything they have and avoiding some CGT. Asian markets have been underperforming the US in recent months so from that point of view perhaps now is not the perfect time to exit. I still have plenty of exposure to the region via EAI, mainly their options, so was happy to lighten up on PAI.

I still believe the region will outperform the US from this point in time longer term. I am mindful though that current emerging markets sentiment may make this difficult to occur if we experience falling global equity markets. More than a year has passed since buying PAI so you can add on other year to my usual overly cautious statements that the bull market is mature. i.e. this is one of the longest bull runs now at 6,7,8,9 years etc. You get the drift. The longer it runs the more tempted I get to trim large bets that have done well. Helps with the sleep at night factor. At least with the EAIO I have remaining I am reasonably confident the downside is capped at zero!

Affluence Funds Management makes the point that last year’s underperformers can sometimes get a re-rating the next year when performance bounces back. I suppose above my sales are protecting me from potentially the opposite occurring. PAI being a standout outperformer in the last 12 months, and on top of that a discount/premium re-rating adding  about 17% to returns. The recent IPO of the L1 long short fund (LSF), is an example that sometimes it is also the previous great performers that mean revert. I don’t mean to have a go at L1 capital. But I just read with interest their recent update about struggling with growth/momentum/expensive? strategies dominating returns versus value/cheap? strategies. It is my coping mechanism for my own lacklustre returns of late to see I am not alone!

The Future Generation Funds look to be now trading at least at the NTA, or even a small premium at times of late. This is another decent change from their earlier life where discounts of 5-10% stuck around for quite some time. It has been an impressive re-rating on the back of some good performance numbers and getting past the weight of the options outstanding. In this example I haven’t yet sold any shares. It is a rare case I feel where the unique product offering could see them develop a consistent premium. After all, assembling similar portfolios yourself would be far costlier. If these ever did trade at a 10% plus premium it also wouldn’t surprise me to see some new shares get issued. The charitable causes would benefit and I would guess there would be plenty of capable fund managers still happy to absorb more capacity to assist the charities. A SPP is more likely for FGG than FGX where capacity is likely to be greater. At this stage this appears quite some time away, and I also could be wrong and they slip back to a discount anyway!

LIC’s for turbulent times get a mention in the Affluence article and I have blogged about ALF & ALI previously that I feel fit this description. I haven’t added to LICs at all much this year but did increase my weight to these two. They certainly also fit the category that Affluence mentions of being last year’s underperformers! ALF I am guessing will look even worse versus the stronger index this month.

My last couple of blog posts have touched on plenty of the obstacles against you in participating in LIC IPOs. I agree with Affluence that it is pleasing to see some of these IPOs now becoming more share holder friendly. LICs absorbing the listing costs and not attaching “free” options is a positive. Recently I thought Wilson may even raise $600 million plus for WAM Global. I made a small punt thinking I might be able to flick it in the first few weeks for a small gain. It was only the second time (apart from WMI) I have ever subscribed to a LIC IPO and it will probably be the last time. I thought it may prove better for a small risk than keeping money sitting in cash for the short term. I got that wrong and sold on the open so no real damage done. Some will think that was silly but seeing a downside scenario of one cent a share with the experiment I don’t regret too much there. Maybe it is a sign though that we are seeing some fatigue in LICs. I have noticed discounts on average widening when glancing at my watch list anyway since WAM Global was launched.

From one point of view though it is a bit of a shame that issuing free options seems a thing of the past. On rare occasions I thought you could spot the odd ones trading cheap on the secondary market. I still own a few different ones although they haven’t been helping me much of late. But I thought they can be useful sometimes in playing the mature stages of a bull market. i.e. with some effective leverage but well defined downside.

I still think we have a long way to go with improving LIC IPO structures and performance reporting. Many fund managers will do what they can get away with. Whenever you get relatively buoyant market conditions then smaller investors will get taken advantage of. Unfortunately I expect that to be the case in the future regardless of any potential improvements in regulation. We will probably just get a different style of tricks to watch out for in the next cycle buried in the 100 plus page prospectuses.

The article notes that smaller LICs have seen discount widening and that some are looking interesting. I am trying to watch them more closely but think I will be a while way from getting tempted. In many cases I feel I need a discount of more like 25% to be compensated for relatively high management expense ratios. I also prefer to see the longer term IMAs getting closer to the end rather than the beginning. I also ideally don’t like to see the fund manager controlling a large conflicted stake in the shares. When the major fund manager owners don’t even have a 5% stake that can actually be a good thing sometimes. It can increase the chances of others buying in and making necessary improvements to LIC’s that have been struggling.

On the topic of the large cap Australian market lagging global markets (Well until the last few weeks!), I mostly agree with the Affluence article. I think CYA is a good LIC for such exposure and is cheap. I see they have mentioned AFI & BKI as potential opportunities which I have been a bit negative on of late. I have felt they may slip from recent premiums to a more permanent discount of about 5% to pre tax NTA. A little bit of this trend has occurred since I last wrote about them though. Therefore I can see where Affluence is coming from as they have cheapened (well not in price lately but premiums being unwound) in the last few months. I would prefer to back CYA to perform better, although that may not suit some investor types who want to keep their underlying fees low. As I am writing this though the ASX large caps are making a strong run into financial year end. I suspect Affluence timed it well as I read about this preference of theirs before much of this strong move. I would be reluctant to rush in now after this bounce. I expected some bounce as tax loss selling dries up mid June but not to the extent seen.

The Affluence article also began by discussing the potential move to LITs rather than LICs in response to Labor’s franking policy. As the LIC sector is already trying to digest a huge increase in supply of products seen in the last 5 years, it is another degree of uncertainty it can do without. I can imagine some investors may get tempted right now in certain situations to dive in where discounts have widened. Some discounts may seem wide when observing the pattern over the last 3 or 4 years. I think this discount widening trend though is a rational response to the increase in supply seen. Also the market has rationally finally discounted some smaller LICs with higher cost ratios and that may not have a proven track record over a full market cycle. It may have also appropriately partially factored in the risks of demand for the LIC structure should Labor’s franking plans eventuate. This is all quite distinct from there being a huge array of fantastic buying opportunities in the LIC space as a result of recent discount widening.

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9 thoughts on “A good reminder on some themes to consider in LIC’s over the next year.”

  1. Great article as usual Steve.

    I must admit the potential for a Labor Govt and threat to franking credit refunds has me being somewhat cautious with LICs. Tax wise it would have no impact on us outside of the SMSF given the size of the portfolio. But should it eventuate I expect price could take a beating especially initially. I want to be in a position to take advantage of this should it occur. In the meantime should the overall market experience a correction I’ll likely favour an index ETF, especially inside the SMSF, until the election outcome and future of franking credit refunds is known. That said, if one of our favoured LICs drifted deeply enough into discount territory I’d likely favour it over the Index ETF.

    As you’ve probably seen, during the process of researching BKI capital raising (more for others ironically) I managed to somehow talk myself into participating in the offer. You saw the reasons why on StrongMoney blog ie FUM sweet spot and minimal embedded capital gains. It’s for these reasons I think BKI is somewhat unique in the older style LIC space.

    Speaking of Labor’s threat to franking credit refunds apart from the likely increase in LITs I saw the below comment elsewhere. Very interesting I thought:

    “Finally, I have been discussing with the Vanguard people and they tell me that they are looking at creating low cost funds to get around the new Labor policies if Labor do win power. If they do that you can let the Vanguard people do all the hard work for you and all you have to do is pay them a minimal management fee to defeat the possible Labor government confiscation of your beloved franking credits.”

    Getting back to LITs I see Evans / Dixon already changing one of their existing LICs to a LIT and the listing of a new LIT. Dixon Advisory have traditionally been a huge supporter of LICs so I thought this was also interesting.

    Otherwise there’s little that interests me in the market at this time.

    Cheers

    1. Thanks Nodrog. Yes for those investors that the Labor changes may not affect too much directly, it may still be worthwhile giving the topic some thought. It is more than a trivial chance the changes could occur. Perhaps certain stocks are more vulnerable and could be a case of you being able to pick them up later on instead. Bit of a mugs game trying to guess these things but just worth being mindful rather than ignoring the issue completely I would have thought.

      For those that face the potential of a big income drop on the back of the changes, I guess you could just wait it out. No certainty Labor win and get the changes through. But if you are cutting it fine income wise and find out later you need to make some changes to your portfolio you run some risk of being late. I.e. Will everyone else may be looking to make similar changes in the same types of securities?

      I saw the evans dixon Asian LIC and move to LIT. I’ll probably try to read more about the mechanics of that move later on. For the time being I’m just thinking that certain LICs are a bit less sensitive to Labor’s changes. If you are buying at a decent discount to after tax NTA is helpful. LICs that haven’t attracted too many low-medium net worth SMSF, dividend only style investors may be less vulnerable. The ones I still own generally fit that kind of description.

      I find that snippet of another person’s comment on a solution from Vanguard intriguing. I’ve only just had one beer as I write this but I can’t get my head around what Vanguard would come up with!

      Before anyone points it out I am fully aware Labor can easily lose the election anyway. Last I checked the bookies had them around $1.50 and I’ve seen plenty of $1.50 shots at the races get rolled. Also the bookies have got some major political events around the world badly wrong in recent times anyway.

  2. Thanks Nodrog for the tip re Strong Money – looks an interesting site.
    If you or Steve have any similar suggestions, would very much appreciate hearing about them.
    Thanks Steve for another thought-provoking post.

    1. No worries Denzil. Yes the strong money Australia blog is a good read.

      As for other sites, for a while I listed a few on one of the links to the right hand on my page under the heading useful web links. It is very cluttered and maybe many aren’t necessarily what you are after. I tried in the end to include some perhaps lesser known sites such as investment blogs. You will have to scroll to the end to see others in the blogging space.

      Depends a bit what you are after and what style of investor you are. The strong money blog is more dividend focused. But I suppose we are both trying to get equity like returns and finding a way to achieve that coping with the huge volatility in prices that it can entail. I try to deal with it by finding assets at a discount which kind of keeps my effective fees low in a way. I also like to spread things out a lot between geographies and asset classes to minimise drawdowns. I do still place a high value on the dividend streams though myself.

      There are also blogs that touch a lot on saving and financial independence retire early (FIRE). I haven’t written about that topic but like to read them occasionally. I suppose I have made a choice to sacrifice salary earning potential to have more choice in how I spend my time. So can relate to some of the discussions.

      If anyone has their own blog or suggestions though feel free to add it in this comments thread, whether it be strictly investing/FIRE or a combination of both.

  3. It’s pretty hard to better Steve’s blog in regard to advanced / outside the square thinking about LICs and the like.

  4. I have commented previously on many of the LICs mentioned, so won’t bore anyone by repeating myself here. With LITs, the problem is that the distributions are all over the place for the equity based ones, although FOR, which I hold, give me a pretty good idea prior to 30 June of what’s coming. With MXT you know what you’re getting, but I already hold enough MXT so am not that interested in buying more. MGG are out of the question as I have too much in MFF. Michael Glennon, by the way, has already had a look at converting GC1 to a LIT. Doesn’t see any great problem in doing so if that proves the way to go.

    I am in a bit of a bind over Labor’s franking credit policy as all my franking credits in 2016/17 were ‘excess’. This year will be about half, as there will be large distributions from a couple of managed trusts. In some ways it may be a good thing in that it will encourage me to sell some things to create discounted CGTs that can be offset by excess franking credits. Though whether selling to make use of franking credits is any more sensible than not selling to avoid CGT is debatable. Or do two wrongs actually make a right in this instance?

    On the other matters, I did not take up my priority WGB as I believe Wilson’s company visit style will not work as well overseas. Already holding substantial FGG was another, albeit less significant reason. I did, however, take up LS1. Fortunately only a small amount. More to comply with Netwealth’s portfolio composition limits than any great love for long / short funds.

    1. The performance fee deters me quite a lot. Also I get concerned when the fund managers grow their AUMs a lot and perhaps it gives them less flexibility moving in and out of stocks. Then I wonder how many beginner investors went in and might have some early regret. The amount raised was incredible. So not that keen. If they charged a more normal sort of fee and the IPO wasn’t so large it would be easier to get comfortable.

      Was just writing it could be a volatile fund though so worth checking their unlisted unit price for a loose guide to their daily NTA if buying or selling. This point was brought up in the AFR today. Now I see they have decided to release daily NTAs.

  5. I thought I would just make a note on this thread that the timing of a SPP / placement for FGG has occurred probably a year earlier than I would have expected. I have sold some of my holding at 1.40 (essentially 2 trades on accounts I can replace the shares at 1.34 later on in SPPs depending on how the price behaves).

    The eagerness to grow the fund and another modest dividend has tempered my enthusiasm a little. Not a major negative for investors with a very long term horizon. I may take up the SPP and hold the same exposure come October, or maybe hold a little less weight now. It was one of my larger weights so a personal preference for it not getting larger again. It does highlight a key point I tried to make with this post that LICs always get very tempted to raise capital as soon as a premium is established, which can slow down the share price. When selling LICs at a premium before such SPPs, for small investors it is often worth leaving a tiny holding in the account as a free option for a potential SPP.

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