I am not sure where I first read of someone describing a buyback of the “Claytons” variety, but ASX Listed Investment Companies are relevant to this topic. Perhaps I first read about Claytons buybacks here. Since then though it is always in my mind when I look at certain companies release their buyback announcements, especially LICs.
“Claytons” refers to a non-alcoholic beverage, the bottle of which was designed to resemble whisky and was marketed in the 1970s and ’80s as “the drink you have when you’re not having a drink”.
In terms of buybacks, I think the article implies the following. That a Claytons buyback is the buyback you announce, when you don’t genuinely intend to follow through with any meaningful effort with volumes. The purpose of announcing it is often when a company is under pressure. They hope that just announcing plans for a buyback can support the share price and show that management is trying to do something. In the LIC sector, an announcement to imply they care about bridging the gap between the discount to NTA. Whether they do care about bridging that gap or would prefer a larger sized LIC to earn more management fees is another question.
LIC discounts widening, LICs vs index funds
Over the last 6 months or so there appears to be a trend of LIC discounts widening. There was a huge increase in overall supply whether it be existing LICs raising more capital or IPOs over the last 5 years. As a general comment the performance versus their benchmarks and various index funds has been poor. This disappointing performance has been compounded for investors paying NTA or even premiums because of discount widening. I tried to make a not so subtle point about my dislike for LIC IPOs when posting to avoid this LIC float in 2018!
If this year the trend of discount widening in LICs continues I suspect it might be the year of the Claytons buybacks. I say this because there are numerous small sized LICs out there that are under a little bit of pressure. They would like to close the discount, but their flexibility is limited the smaller they are. If the LIC is only around $50 million in size for instance, fixed costs of running it can already be a burden. Although they may like the idea of announcing a buyback, they would also be concerned about making this problem worse by shrinking the fund when they execute the program. Not to mention the fact that a reduction in size leads to less of a base management fee lining their pockets. Some are already under pressure and I already wrote last year about LICs that are probably too small and are “creative” with their performance reporting.
When fund size should not be a concern in implementing a buyback
Argo Global Listed Infrastructure (ASX: ALI) has ran what some may view as a Claytons buyback in recent years. In this case though with assets of more than $300 million I would have thought there was a good opportunity to have bought back 10% of the units at a discount to NTA of 15%. I still hold ALI so fortunately the fund performance has improved in an outright sense (not necessarily versus its benchmark). This has seen the discount to NTA contract in recent months.
The last year has been excellent in terms of the NTA performance of 21% to end of Feb 2019. Having said that they still underperformed their benchmark in this period. The NTA performance since inception to the end of February this year was just 6.9% per annum. In my opinion when the fund has fairly ordinary numbers since inception like this, it is surprising that they wouldn’t use the buyback more. Why not take the opportunity to buy back a full 10% each year at such a large discount it was at for a long time? I think it spent years trading at least a 15% discount to NTA. Seems like a risk free way to me to boost the NTA each year, given the fund has previously struggled to get 7% per annum. I know they like to run a low cash weighting but even selling some liquid holdings in the portfolio to buy back shares may still have been worth it. In 16/17 they bought back only about 1.4% of shares outstanding. The current financial year might end up about the same. Fees in this LIC are a little unusual.
A future Claytons buyback in the making?
NAOS Small Cap Opportunities Company (ASX:NSC) has just announced a buyback that can commence on April 15th. Fortunately I don’t own any of the NAOS LICs over the last year or two, although I feel a little embarrassed in some ways as I have previously thought NAOS were good stock pickers. They have certainly struggled over the last couple of years. I just wonder if this is an example where chasing more AUMs has led to a drop in performance.
With their first LIC in NAOS Emerging Opportunities Company (ASX:NCC) they got off to a great start. It is a great advantage to your potential performance numbers when you manage a very small fund size like it was at this time. Once NAOS EX-50 Opportunities Company (ASX:NAC) came about, then they added significantly to their AUMs taking over the Contango LIC (CTN) their performance has suffered. The more money you have makes it harder to get set in smaller stocks or get out of them for that matter. Also planning and dealing with taking over CTN, along with the disgruntled shareholder base (quite reasonably so by the way) could have been a distraction to the business of analysing stocks.
I digress, back to the buyback coming up with NSC. The fund has over $100 million in assets, so it is not the size necessarily that I see as the greatest limitation to them executing this buyback. Along with the obvious reason that many LICs don’t follow through with buybacks (hurts their future management fee income), I see a couple of other reasons this could turn into a Claytons buyback.
According to their NTA report as at end of February I see a cash weighting of only 0.46%. I also see convertible notes on their balance sheet of more than $25 million. These have to be dealt with somehow in the next 12 months.
The above may not be as much of an issue if they had a very large liquid portfolio. Yet they run a very concentrated portfolio, their NTA report notes that they hold only 10 stock positions. We are talking about a small cap fund here so we can see that they may not be in such a flexible position to execute the buyback in a meaningful way.
NAOS and Contango history
I have sympathy with how the former CTN shareholders have been dealt with by both NAOS and formerly Contango Asset Management in recent years. As a non-holder I actually would like to see this work out well for shareholders from this point in time. A few years back Contango management reversed a previous decision to outsource part of the fund’s management duties to another fund manager (OC Microcaps Fund). I haven’t checked how OC has done in the last year, but my understanding is former CTN shareholders would have been extremely better off if they kept OC as another fund manager.
If you have some spare time on your hands, some of the history can be seen in the following links with a couple of articles from Michael Pascoe.
I commented on the issue in part here, that the NAOS investment in CGA was looking a little worrying.
I could easily be wrong of course and maybe NSC will actively implement this buyback. After all the discount seems to be getting wider and wider so this may tempt management to follow through with it. Shareholders should make themselves aware though of the convertible notes outstanding. Also be aware of the break fee in the IMA that is mentioned in the Michael Pascoe article from November 2017.
Any other “Claytons” buybacks going on out there?
Feel free to drop a comment below this post if you feel there are some other LICs out there that are running with a “Claytons” buyback.