Guest Post – The ‘Melbourne Cup of LICs’: Our form guide and three favourites

This is a guest post that I thought would be of interest to my readers. It is in the spirit of Melbourne Cup Day, so I will be tempted soon in having my own punt on a LIC trifecta in the comments section at the end (feel free to do the same). Please read below to find out more about the author. (Note I have no affiliation with the below author / business).

About the author:

Daryl Wilson has over 25 years’ experience in finance and investing. He formed Affluence in 2015 to give everybody access to the investing model used by the ultra-wealthy. Investors can access over 30 of Australia’s best boutique investment managers.

Refer to the Affluence Fund’s website below for more details.

https://affluencefunds.com.au/

What if there was a Melbourne Cup of Listed Investment Companies? Who would make the starting line? Who would win? We have analysed the field of well over 100 LICs. Here are our 24 starters for the 2019 “Race that Stops the Investing Nation”, and our three winners.

The Melbourne Cup of LICs

We are proud to present our third annual form guide for the Affluence LIC Cup. The LIC Cup is possibly even more important than the Melbourne Cup. There’s approximately $44 billion of investors (hopefully not gamblers…) money at stake in the LIC sector, so it’s certainly a lot bigger.

To win the real Melbourne Cup requires a horse that is well trained, has a great jockey, and importantly hasn’t been hit too hard with a weight handicap from the stewards. To win the Affluence LIC Cup, an LIC requires many of the same attributes. They require a great trainer (the investment manager), an opportunistic jockey (the individual portfolio manager responsible for investment decisions), and a favourable weight handicap (starting discount or premium to NTA).

Last year’s race was very different to this year. The 2018 LIC Cup was run on a very soggy track (falling equity markets). However, the stewards had maintained fairly average handicaps last year (discounts to NTA were reasonable). 

This year, the track is looking lightning fast, with the ASX 200 up over 20% this calendar year and the S&P 500 near all time highs. However, the stewards appear to have lost the plot and drastically reduced handicaps (increased discounts) across the board. This could perhaps make it a good time to “have a punt” on a few LICs.

Who would make the cut?

We have analysed the field of over 110 LICs, and here, in no particular order, are our 24 starters for the “Race that Stops the Investing Nation”. Don’t feel bad if your favourite “horse” is not in the list. The quality of LIC runners is very high right now and there are many more that could have made it into the field this year.

LIC Starting Handicap Affluence Form Guide
NAOS Ex-50 Opportunities (NAC) and NAOS Small Cap Opportunities (NSC) 15%+ discount These stablemates use very similar training techniques, however often fly beneath the radar. After a very rough period up to mid-2019, both have rebounded strongly with all guns blazing and are looking at putting the difficult times behind them. Through the hard times, they stuck true to label and did not deviate from their training philosophy. Ones to watch.


NGE Capital (NGE) 20% discount One of the smaller runners in the field, but this LIC uses that to its advantage. Likes to take big chances and could be a real challenger. Concentrated deep value training regime. If things go its way, it could win by furlongs. Worth a punt.


Blue Sky Alternatives Access Fund (BAF) 22.5% discount The original trainer made some terrible mistakes and has been marched out of the stables. Stewards have responded with a very light weight. While the potential hasn’t fully materialised yet, it remains one of our favourites. Currently under the tutelage of a temporary trainer, which isn’t ideal. The search for a new trainer is on, but in fact, retirement (wind-up) might be a better option. Either way, it seems very unlikely the current situation can continue, and we anticipate a fast finish once we enter the final straight.


PM Capital Global Opportunities Fund (PGF) 20% discount We think the stewards have it all mixed up here. The jockey’s long-term track record is top class, the LIC is a reasonable size, yet it has been blessed with an easy 20% discount to NTA. We believe this is one of the best prospects for global trainers to pull off a win.


WAM Capital (WAM) and WAM Research (WAX) 20% premium Despite not being in top form in recent races, the stewards have not reduced the handicap for WAM and WAX in line with the rest of the field. This trainer knows a thing or two about long races, and we can’t doubt the long-term record. However, a 20% premium seems fanciful and highlights the potential danger of backing LICs purely on a dividend yield.


Antipodes Global Investments (APL) 15% discount An excellent global trainer in with a good chance. Performance over the last couple of years has been below par, however we put a lot of this down to unusual track conditions. Like all LICs trained in the long short style, will struggle to keep up when the field is at full pace. However, this is a long race, and this is a true stayer, so it’s definitely in with a shot.


WAM Leaders (WLE) 5% discount We still can’t work out what the stewards are doing with this one. Stablemates WAX and WAM continue to be hit with sky high premiums. WLE has substantially outperformed both, yet is 25% relatively cheaper than WAM and WAX. We think it looks pretty good at this level and expect another strong race this year.


Australian Leaders Fund (ALF) 15% discount This LIC has now run sideways for five years and is showing little sign of improving. It’s a wet weather specialist, and there has been very little rain. On the right track it may have a chance. However, the owners are getting restless, and it appears they are demanding more action. Could be a chance if the owners get aggressive. If performance doesn’t improve soon, likely to be retired.


Tribeca Global Natural Resources Limited (TGF) 17.5% discount Hasn’t yet shown the kind of speed that we believe is possible from this LIC. Its unlisted stablemate has shown that on its day it will outpace virtually any competitor, however almost impossible to predict when this might happen. A roughie.


Henry Morgan Limited (HML) and Benjamin Hornigold (BHD) No idea Named after pirates, and with a curious style of racing with only one blinker, little else is known about these Brisbane based stablemates. The stewards are continuing to pursue several enquiries, for both the LICs and trainers. The two LICs have not been seen for quite some time but are believed to be gravely injured, which would be a very sad outcome for the owners.


Monash Capital (MA1) 12.5% discount This LIC has been powering along all year, with the jockey and trainer performing very well. Has been helped by an admirable decision to change the ownership structure for the owners to realise value. Given the intentions, we are surprised how big the current discount is. This LIC is a real chance in what could be its final year in the big race.


Bailador Technology (BTI) 20% discount Unfortunately, this LIC peaked well before this year’s race. After performing fantastically during the first half of the year, it has had a couple of stumbles recently. Not one of our favourites at this handicap, however very hard to predict and we could be surprised.


8IP Emerging Companies (8EC) 25% discount Will only barely make the start of the race and has become a victim of the times. After a period of poor runs and trading at a very large discount, the trainers made the difficult decision to retire the LIC after this race. We very much doubt if this will be the only LIC that treads this path.


Ophir High Conviction Fund (OPH) 5%+ discount A new entrant to the race this year after very successfully competing in the unlisted events up to December 2018. These jockeys have a performance history second to none. Their training methods have suited the tracks perfectly in the past few years, and we are unsure how they will perform if track conditions change. Still, quite an attractive handicap at a 5%+ discount.


Sandon Capital (SNC) 15% discount There has been some horse trading (pun intended) with this LIC, as it has recently combined with its part stablemate Mercantile Limited (MVT). We were already fans of the Sandon jockeys. Now they also have the additional resource of a very experienced (retired) jockey as well. We believe this is a very attractive opportunity at the current discount weight.


Thorney Opportunities (TOP) 20% discount This LIC comes from the stable of one of the wealthier trainers in the race. On a portfolio basis, one of the top performers since its inception. However, the stewards have still graced it with a generous 20% discount. While this goes against the theory that good performance will lead to a narrower discount, the trainer does charge very high fees, which some owners are sensitive to. Despite that, we still think this LIC is in with a good shot this year.


Global Value Fund (GVF) Small discount UK horse with an Australian jockey. Consistent performances have seen the stewards hand out a very small discount as a handicap. Given the relatively heavy weight, this LIC will likely find it hard to win in the short term. However, runs well on all tracks and we have no doubt it will continue to be a strong long term performer.


Future Generation (FGX) and Future Generation Global (FGG) 10% discount Brilliant stayers and the longer the race, the better these two will perform. Over the long run (perhaps over 3 to 5 race distances), regardless of any changes in track conditions, they will just keep going. Best credentialled combination of trainers and jockeys in the race. Current weight of 10% discount looks favourable for both.


L1 Long Short Fund (LSF) 12% discount This huge LIC journeyman is looking for redemption and is well on track to achieve it. When LSF started racing in the big league, it appeared to throw a shoe early and lost a lot of ground very quickly. This year has been much improved, with the jockeys showing a lot of commitment and the results are looking good. Momentum is building nicely, and this is one of our top picks.


Australian Foundation Investment Co (AFI) Around NTA This huge mare and local favourite seems like she’s been around forever. Largest horse in the field and still a solid racer. Usually around mid-pack but struggles to have the top speed to win in any given year. Briefly looked exciting earlier in the year at a near 5% discount, however, the field has since caught up. Expect another solid but not spectacular result.


Regal Investment Fund (RF1) Around NTA A very recent addition to the race from the unlisted competition. This trainer and jockey are responsible for the best unlisted fund performance history over ten years on Morningstar. This horse is not quite as exciting as its league topping stablemate, but that doesn’t mean it won’t keep up given the right conditions.


Cordish Dixon Private Equity Funds 1 & 2 (CD1, CD2) 20% discount These stablemates were listed to start but are both late scratchings. It appears the trainers have been quietly seeking other owners. They recently put a proposal to existing owners to sell at a 15% discount to market value. There are unconfirmed rumours that this has not gone down well…


Metrics Income Opportunities Fund (MOT) Small premium In our opinion, one of the best runners from a field of debt-based LITs to have tried out for the race in the past couple of years. A remarkably consistent performer, but without the legs to go with the field at full pace. Will finish in the money if it rains hard but otherwise likely to be mid field.


Morphic Ethical Equities (MEC) 24% discount Global runner. Recently moved across to the Ellerston stable, but the existing jockeys have stayed with the horse. Trained using the highest environmental, social and governance practices (no whipping allowed). Performance has been average but has been allocated an attractive discount by the stewards, so in with a chance.

Who would fill the top 3 places?

Like the Melbourne Cup, the field is wide open this year, and you should always expect the unexpected. But we realise everybody loves a hot tip, so here are our picks for the year

All three are currently key holdings in our LIC portfolio.

Monash Absolute Investment Company (ASX code: MA1)

MA1 is one of the smaller LICs and is managed by Simon Shields and Shane Fitzgerald of Monash Investors. MA1 listed in April 2016 off the back of some excellent performance in their unlisted fund which uses a very similar strategy. Unfortunately, this corresponded with the start of a period of underperformance. The LIC quickly came under pressure and started trading at an increasingly large discount.

The management team and board tried various initiatives to close the discount, with not much success. Even this calendar year, when the managers have achieved a fantastic portfolio return of 36%, the high discount persisted (above a 20% discount to NTA). In August 2019 the company announced that they proposed to restructure MA1 from an ASX listed LIC to an ASX Exchange Managed Traded Fund (ETMF). Unlike a closed-ended LIC, an EMTF is an open vehicle that uses market makers to ensure it trades in a very tight band around NTA.

This proposed solution would allow investors to access the managers’ strategy through the ASX. It would also permanently eliminate the shares trading at a substantial discount. The main disadvantage of this proposal is for the investment manager, as they lose the significant asset of having a fixed amount of capital to manage. Monash Investors have put shareholders’ interests above their own, and we commend them for this decision.

There are a few hurdles for the proposal to be completed, with the main one being ASIC has put a freeze on new ETMFs until it completes a review of the sector, which is expected to be completed in the next few months. Hopefully, common sense will prevail as this proposal is clearly in shareholders’ best interests. There are also several steps that need to be taken to complete the transaction, including a shareholder vote.

To us, the most surprising part of all this is that even with this clearly stated intention to get rid of the discount permanently, the shares are still trading at a 10-15% discount to NTA. There is still market risk, however this is the case with all similar ETFs and managed funds. There is also the risk that the proposal does not proceed, for example due to the ASIC review or investors not approving the vote. However, based on our last count, approximately 27% of the company is now held by substantial investors (those who own more than 5% of total shares). We believe these holders now expect that one way or another, the discount gap will be closed. Therefore, even if the current proposal did not proceed for some reason, these investors will be active in demanding some other solution to achieve the same result.

Blue Sky Alternatives Access Fund (ASX code: BAF)

BAF was one of our top pics last year, and while it has taken longer to play out than we expected, it remains one of our top picks today. BAF has traded at up to a 35% discount to NTA over the past 12 months, although this has recently improved to around a 22.5% discount.

The discount does not reflect portfolio performance; the BAF portfolio has returned 6.8% over one year and 7.2% per annum over three years. Nor is it because of high gearing, as it currently has approximately 25% of assets in cash. We believe the key reason the discount persists is that the name of the LIC includes “Blue Sky”.

Over the past 12 months, while not much has happened for BAF, there have been big changes for the investment manager. Blue Sky Alternative Investments Limited, the parent of the manager, had administrators appointed during the year after defaulting on a convertible note issued to Oaktree. It appears likely that all equity in this company is lost, and the manager will ultimately end up being owned and controlled by Oaktree. While this is bad news for the investment manager shareholders, there is very little direct impact on BAF.

Part of our investment thesis last year was that it was likely a new investment manager would be appointed for the LIC. During the past 12 months, the independent directors of BAF have worked very hard to try and make this happen. The board recently announced that if they cannot come to a satisfactory agreement with the current relevant parties soon, they will consider other options available to them, including a windup and return of capital. In our view, that would be the best course of action.

Reading between the lines, it would appear that we are now at the pointy end of a decision being made. Whether it’s the appointment of a suitable new manager or a windup of the vehicle, we believe the current 20% plus discount on offer is very attractive. Some of the underlying assets are illiquid and may take an extended period to realise. However, there is 25% cash which could be distributed very quickly. In addition, a holding in the Blue Sky Water Fund represents another 25% of BAFs assets. This stake has previously attracted offers at a premium to book value, and we believe it could be very attractive to other water rights investors and investment managers.

L1 Long Short Fund (ASX code: LSF)

One of our core aims in constructing portfolios is to identify top tier managers. We find they often have a number of similar attributes; they have outperformed a fair benchmark over a reasonably long timeframe, they usually outperform in down markets, the portfolio managers have significant equity in the investment manager and underlying investment strategy, the portfolio managers have extensive history together and are responsible for the track record, and they have wide asset allocation discretion and have a fairly unconstrained investment strategy.

The above attributes summarise L1 Capital pretty well. Their long only unlisted fund has outperformed by 3% per annum over 12 years. But like virtually all great managers, they also have periods of poor performance. This was the story with the L1 Long Short Fund, which listed in April 2018 just as the investment manager slipped into a period of poor performance. Leading up to the IPO, the unlisted fund had achieved 39% per annum returns over the prior three years. Through a combination of the poor investment performance since listing and the obvious disappointment of investors, the share price fell from $2.00 at IPO, to a low of $1.27 in late 2018.

One of our favourite situations is when a great manager goes through a rough performance period. We believe this is an opportune time to invest (or top up). This situation is even better when you can access the strategy through an LIC at a substantial discount. The recovery is already well underway, with the NTA up over 20% off its lows and the share price back to $1.60. The current discount to NTA is around 12%, which we believe can continue to recover if the good recent performance continues.

Before you invest, read this!

We encourage you to do your research before investing in any LIC. Remember, a great LIC and a great manager is only part of the story. We also like to make sure they’re trading at the right price and that the assets they are investing in are not themselves overvalued.

If you would like to know more, Affluence recently presented at the ASA Listed Investment Company Showcase events in Sydney, Melbourne and Brisbane along with an exceptional line up of LIC managers. We spoke about the features we like about the LIC market, the key things we look at when assessing a LIC and how they might fit into your portfolio. We also looked at a variety of investment themes you can access through LICs and explained why the most exciting opportunity in the current LIC market is the ability to access a wide range of LICs at discounts to NTA well above average. Click here to watch the 30 minute presentation in full.

Take care and all the best with your investing.

About the author:

Daryl Wilson has over 25 years’ experience in finance and investing. He formed Affluence in 2015 to give everybody access to the investing model used by the ultra-wealthy. Investors can access over 30 of Australia’s best boutique investment managers.

Refer to the Affluence Fund’s website below for more details

https://affluencefunds.com.au/

2 thoughts on “Guest Post – The ‘Melbourne Cup of LICs’: Our form guide and three favourites”

  1. Ok so here goes with my trifecta of LICs for the year ahead. Please don’t blindly copy, as I have showed with this blog they don’t always work out! One of the three was noted as one of Affluence’s picks so I wont add a great deal more there.

    BAF – I have occasionally mentioned this on the blog at lower price levels. Yet the sale of some student accommodation assets were a bit better than I had imagined. Therefore there is probably fairly attractive returns even from current prices given the portfolio is sitting on plenty of cash. My suspicion is the potential new trainer options might be asking for higher fees than is warranted. If that is the case, as one of the owners here I might vote for retirement (wind up)!

    ALF – I have included this in the trifecta on the assumption that we run into some wet tracks over the next year. I note that the recent handicap (NTA discount) has been close to wides despite improved performance this financial year to date. We also are likely to see the large off market buyback take place soon. Holders might be able to pick up a quick 10% gain for 20% of their holding. That is a handy tailwind, and we might see future larger similar moves. Either that, or a wind up could come into play if performance struggles once again. If we do see a bear market it’s not a bad LIC to own. I prefer the upside potential compared to if I just sat on cash in my portfolio. Regular buybacks are accretive to NTA which helps offset fee drag, which is a big issue for many other LICs.

    NGE – This is an unusual LIC to round out the trifecta as I want to make it clear that unlike the first 2 mentioned, I do not actually own this LIC. So why have I included it? Well I personally own a couple of energy stocks directly in KAR & HZN that are big weights in this LIC, so I don’t necessarily want more exposure via buying NGE. When I say big weights, I do mean they are big for NGE. KAR being almost half the fund size as I write!
    I think this sector is one of the few attractive contrarian bets that exist in today’s markets and these stocks aren’t a bad way to play it from here. Clearly if KAR comes off then NGE may win this LIC Melbourne cup by 6 lengths or more. Hence I thought I would try my luck and include a riskier LIC in my trifecta here.

    Good luck with any gambling today, whatever Melbourne Cup you are trading!

  2. I must admit I had yesterday’s prices in mind when choosing my trifecta. It’s still quite early in Asia where I am right now so hadn’t yet checked the market open. So don’t really know a particular reason why for example ALF and BAF hit 99 and 89 respectively. Perhaps thinner markets and some drunk investors trading from the Melbourne cup?

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