Pressure has been mounting on many ASX LICs this year to address issues of sub-par performance and widening discounts to NTA. In some cases this has led to corporate activity in the sector that has subsequently seen strong returns in the shorter term for such LICs.
It made me reflect on what signs we should be looking for to position for LICs that have added potential. That is the extra potential due to a possible takeover or a wind up that closes the discount to NTA.
To summarise some key factors to look for, I see these five areas amongst the most critical (but not the only factors).
1) Discount to NTA of circa 20% (if it is only in the 10-15% range I often hear LICs provide the excuse that many other LICs experience discounts and this is normal, so nothing changes from management).
2) Activist shareholders going substantial / Top 20 shareholders – The most well known is WAM Capital Ltd (ASX:WAM) agitating to change the structure of underperforming LICs. Obtaining 5% enables them to call meetings to propose alternatives. We have also seen Sandon Capital Investments Ltd (ASX:SNC) and the Global Value Fund Ltd (ASX:GVF) active in campaigning for changes in rival LICs in the past.
Such stakes should be viewed in the context of other major holders. For instance sometimes the fund manger may also hold a large block in its own LIC that can act as a barrier to prevent any change.
3) Investment Management Agreement – Most LICs that have launched in recent years have agreements lasting 10 years and can often include expensive break fees. Even though the shareholders may wish to wind up the company only a few years into its life, this can complicate matters. For example aiming to close a 20% discount by winding up a LIC does not sound as enticing if this involves losing 5-10% of this because of having to compensate the fund manager.
4) Hidden Value – Sometimes in my opinion the market tends to under appreciate certain “hidden value” inside of the LIC. This could be realised quickly in the event of a takeover or a wind up. Some examples here are tax losses and franking credits. One reason it may go underappreciated is many LIC investors may just focus on the pre-tax NTA, and perhaps not read the annual report and notice the tax losses or franking account balance. The law can enable one LIC to takeover another and still utilise such value contained in the target LIC.
5) Ongoing Fees & Costs / The cost of waiting for the catalyst – This can be a tricky one since often the LICs that are ripe for activism have high management expense ratios. I would just note here though if you are positioning for a possible takeover or wind up take the MER into account. You need to be more certain of this likely event occurring in a shorter time frame when dealing with LICs with high MERs. For instance if a 20% discount to NTA is closed over 4-5 years, and the MER is about 4% each year, the trade may not do so well.
Conversely, if you identify a target LIC with lean costs then this can substantially mitigate the risks with the overall strategy.
I would also add that identifying targets that have a high probability of being taken over or wound up is usually not easy. So ideally you want to find a LIC that you are comfortable owning even without this catalyst.
So what are some LICs that may not survive in their current form in the medium term?
I noted in the Rask article link that in recent times we have seen 8IP Emerging Companies Ltd (ASX:8EC), CBG Capital Limited (ASX:CBG) & Monash Absolute Investment Company Ltd (ASX:MA1) undergo significant changes, so which LICs may be next?
Please note this does not mean I necessarily think the below LICs are good buying opportunities. I just think they are vulnerable in the medium term to undergo change due to either wide discounts to NTA or underperformance, or both. Being an investor for a living, I think it helps to have some specialised pockets of the market to focus on. I see this as an area that most other investors find boring, so I often glance here first.
It is also by no means a full list. Just some LICs that quickly came to mind. With about 115 LICs out there I am sure there are others. Please feel free to comment on this blog post with others I haven’t mentioned.
This blog post will drag out forever if I write in too much detail below so will try to limit it to some brief key points in each case. All are at wide discounts to NTA that most shareholders do not like, so I won’t bother repeating that this is a factor below in each case.
Contango Income Generator Ltd (ASX:CIE) – Recently Wilson Asset Management have gone substantial. The performance of this LIC has been disappointing. Not sure if the IMA gives the manager much protection, since there was a lot of shuffling around in terms of the ownership of Contango after this LIC commenced.
Australian Leaders Fund Limited (ASX:ALF) – Last year we saw the manager transition two LICs to unlisted funds. Recently they announced a regular off market buyback plan to address the large discount to NTA. I would argue though they should be making this at least twice as large as planned, and that it should have happened a year ago.
Performance has been horrible over the last 5 years. A very long lasting LIC that got away with a long term IMA that these days is not possible. I believe this still has many years to run. Yet if performance continues to languish then management and the board may be willing to also transition this to unlisted. They seem a bit more sensitive to shareholder’s frustrations with the discount than I have seen with other LICs anyway.
As a shareholder here I’m somewhat underwhelmed by the capital management news. Feeling like voting against the remuneration report again and I suggest other holders give this some thought.
The way they report their pre and post tax NTAs is arguably a tad unconventional!
Fat Prophets Global Contrarian Fund Ltd (ASX:FPC)– One of many LICs in recent years that in my opinion is too small to warrant an IPO in the first place. Compounding the problems are very excessive fees and underperformance. There are many criticisms an activist campaign could point to so we may soon hear of some. Still relatively early days in the context of the IMA though.
Templeton Global Growth Fund Ltd (ASX:TGG) – Activists already applied pressure on this LIC a few years back. I think they have done a fair job in terms of corporate governance since and trying to promote the LIC. Yet the fact remains they have suffered further underperformance with value investing being on the nose, and the discount to NTA is still very wide.
TGG might be better off taking a leaf out of ALFs book although ideally make an even larger off market buyback. The size of the fund enables them to consider such capital management programs. Might be more effective than fiddling around with small on market buybacks.
A few weeks ago it was announced the portfolio manager Peter Wilmshurst is leaving. Staff turnover like this arguably not ideal as they try to justify keeping this very long standing listing going.
Blue Sky Alternatives Access Fund Ltd (ASX:BAF) – This is already playing out as recent announcements suggest we will soon see a change in manager. The door is also still ajar for at least a part if not full wind up potentially.
As a shareholder here, I’d probably like to see at least a good portion of the assets be very patiently sold to fund a capital return. If they can get Wilson Asset Management as the new manager that might be worth considering for some of the portfolio. They have the reputation and distribution / marketing reach to close a lot of the discount. Simply a name change to something like WAM Alternatives or the like may make all the difference.
Cadence Capital Limited (ASX:CDM)– High conviction manager that chalked up a heap of alpha in one stock a long time ago. Recently this high conviction approach has come unstuck. Don’t think it has much protection to survive from the IMA. Questionable reporting of performance at times.
NAOS Small Cap Opportunities Company Ltd (ASX:NSC) – Poor performance, manager has other LICs that are managed in a similar way, highly disgruntled shareholder base. Some issues are refinancing some debt soon and a break fee in a rather long IMA still. Controversy in the way it handled the takeover of CTN.
In fairness I should note NAOS has seen a nice bounce in performance for them across August / September. Despite that the discount remained large even after they announced this. Perhaps one day some sort of merger between their LICs will be considered.
Ellerston Global Investments Ltd (ASX:EGI) – I think the manager here has done an ok job, although one criticism is the way they handle underwriting of options in the past. Despite all this it trades at a large discount, is more than halfway through a 10 year IMA, and I believe activists are looking at it.
Morphic Ethical Equities Fund Ltd (ASX:MEC) – Was a poor IPO structure in terms of size, listing costs, free options etc. Has underperformed the market since listing. Question marks over being able to add value from ETFs within the portfolio / making macro calls. It is earlier within its IMA though so may take awhile before change is suggested. Will be challenging for it to survive in the current form in the longer term. Dilutive share issuance hasn’t helped its relationship with a lot of the shareholders. Have seen changes in the ownership structure of the fund manager.
Ok so perhaps I wont be on the Christmas card mailing list for some of these LICs, but readers feel free to comment on the blog post if you think I am being unfair with some of the above observations. And as I said earlier, to discuss other LICs aside from the above that may struggle to survive longer term.
Just for disclosure purposes, at the time of writing these are the LICs from the above list that I own – ALF, TGG & BAF.