I expect on balance discounts on LICs to continue to contract in 2021, mainly due to a lack of supply. It is therefore no surprise that I am not expecting a great deal of LIC IPO activity next year. There was controversy surrounding sales commissions and LIC IPOs that got plenty of attention in 2019. (This was after a flood of new issuance in the few years prior, with many poor performers). For this reason, I do not think financial planners and investors have great appetite yet to take the plunge into new closed end fund products.
What was driving ASX LIC discounts to narrow late in 2020?
- Lack of new issuance as I just discussed. The cynics might suggest some advisors will now not show the willingness to recommend new closed end funds going forward because commissions were banned in 2020.
- Not only does fewer IPOs reduce LIC supply that would otherwise be the case, existing LICs are ceasing in their original form. We have seen a pickup in them getting taken over, wound up, or converted to open ended funds. This is even further pressure on the diminishing supply of LICs.
- There is still a strong level of core demand out there for the closed end fund format that may even be increasing. One key aspect of this is the “dividend smoothing” feature of LICs. Investors are increasingly adopting more of the view that you can hardly earn anything at all in the way of income from fixed income or cash. Rightly or wrongly, LICs that are providing a few years of strong guidance surrounding a future fully franked income stream, are being seen as the next best alternatives.
Does that mean many ASX LICs are great buys in 2021?
No, not necessarily. My points above are just my slight bias that I expect a bit of a tailwind to overall returns as the chances of the discounts on many LICs contracting are good. This is only a small part of the equation, as the movement in the underlying NTAs are likely far more important.
Also any reduction in some of the LIC discounts from here are not likely to be as meaningful for returns as recently seen. For instance, we have seen in many cases from shortly after the bear market in early 2020 some huge narrowing of discounts. In other words, has the easy money been made, yes.
To put some more context into the above points, I personally just am using these positive demand / supply trend in LICs to not rush out of all my LIC positions in a hurry. I have done ok in 2020 in Australian Leaders Fund Limited (ASX:ALF) and Contrarian Value Fund Ltd (ASX:CVF) for example. They are in the process of discontinuing on the ASX and I am not looking at replacing them in my portfolio with new purchases of other LICs. I have also sold more than half of my position in L1 Long Short Fund Ltd (ASX:LSF) in recent months, unfortunately I guess mostly a bit below 1.50, yet I still own some as we approach 2021.
Then there are a few other LICs still in my portfolio that I have watched the discounts contract from around 20%, to closer to 10% or even smaller in the back half of 2020. These ones in their history have had stints of trading at premiums. It would not shock me if these few that I have in mind trade above their pre-tax NTA at some point in 2021. I therefore have only trimmed such holdings in recent months and plan to likely keep at least half of my holdings throughout 2021. I know this sounds like sitting on the fence, but that is the way investing is sometimes. The few that I refer to here are Future Generation Global Investment Co Ltd (ASX:FGG), Ellerston Asian Investments Ltd (ASX:EAI) and Forager Australian Shares Fund (ASX:FOR). These 3 are at least a bunch that I consider have relatively fairer fee structures and less negative risks surrounding any poor corporate governance. Two factors that I believe are often usually behind LIC investors achieving poor returns.
The battle for franking. How you can take advantage of franking credits.
As I mentioned earlier, we have seen more consolidation within the LIC sector in 2020. WAM Capital Limited (ASX:WAM) have been busy targeting Concentrated Leaders Fund Ltd (ASX:CLF) and Contango Income Generator Ltd (ASX:CIE). The former had long sat on a large pile of franking credits. We also saw Global Value Fund Ltd (ASX:GVF) try to merge with Contrarian Value Fund Ltd (ASX:CVF). The fact that CVF was also sitting on a good amount of franking credits was part of the appeal to GVF. I think this is a good area to watch in trying to discover potential targets for acquirers. Sometimes I think the market can be slow to see the value in such large piles of franking credits sitting on the balance sheet. Even after deals have been announced the market can under appreciate the value. Just in the last few months for example I have picked up a couple of stocks after windup proposals were already announced that contained plenty of franking credits to release.
WAM Capital Amaysim Takeover
I refer to Sunland Group Limited (ASX:SDG) and Amaysim Australia Ltd (ASX:AYS), which have continued to appreciate after their initial spikes on the news. They are not LICs by the way, but funnily enough WAM capital are so keen for that franking credit value they have made a proposal to Amaysim.
This battle for franking ties in with the point I made earlier about LICs wanting to provide some strong future guidance of fully franked dividends. This is a tool that is increasingly being used to narrow the discount to NTA. LICs believe they can appeal to investors who are frustrated by earning next to nothing on term deposits or fixed income. They are striving to paint a picture of a very safe future income stream. Anything that sells I guess.
I have touched on the topics of identifying “hidden value” on the ASX in previous blog posts such as here and here. They may be worth a look for newer readers of this blog if you are interested in such strategies.
When does the pipeline of ASX LIC IPOs improve?
Well I have hinted I do not think it is on the cards for 2021, how about 2022? Perhaps, but what will be the marketing channel used if they have lost the network of advisors and brokers willing to plug them? I am not sure I have the answer to this, perhaps it takes longer, and new product offerings continue to favour the open-ended structure.
However if LIC discounts do happen to contract further don’t write off just how alluring for fund managers it can be to still launch closed end funds. Perhaps their new selling channels eventually turn more to the likes of Livewire markets, Firstlinks and Switzer for distribution and awareness? If the ASX still allows 10-year Investment Management Agreements fund managers will still want to “lock in” AUM fee revenue for the long term. As I pointed out in my last discussion on IMA termination fees, you can see how the minute you get an ASX LIC off the ground, it can kind of be like receiving an instant gift for many millions of dollars. This is due to the difficulty of terminating any IMA.
I would be interested what readers think here, do you see any prospects of LIC IPOs to come back in 2021, feel free to comment further down below.
Are share purchase plans (SPPs) good?
Also be on the lookout for existing LICs in 2021 to issue new shares as soon as they start trading at the NTA for a few minutes. The usual suspects will cite reasons such as increasing liquidity and awareness of the LIC, reducing the fixed costs as a percentage, and great new opportunities to invest the new money. In some cases these can be good reasons I will admit. In most cases I see though, these are often weak reasons they give. The reason you will not hear will be because it increases AUM fee revenue for the manager. I wish I could truly believe that LIC boards always have existing shareholders in mind when dishing out placements to new sophisticated and professional investors.
The LIC stock pick I had for 2021 that didn’t last long!
However that is not such a bad thing as I shall explain. Usually once a year I discuss a hypothetical “do nothing” type portfolio with quite a few LICs. I might make a change or two at most and discuss LICs and their prospects for the next year. In doing that recently in a November blog post the LIC I highlighted will end up only lasting about 2 months!
I had plucked out Contrarian Value Fund Ltd (ASX:CVF) as one that I was adding to my lazy portfolio experiment. I thought it would get taken over by Global Value Fund Ltd (ASX:GVF) and it could retain market exposure via that for a long time. Although GVF did indeed try to do just that, in the end it is being wound up and converted to cash. This means that the issue I was trying to address is still there, that cash will still soon be too high in this hypothetical portfolio.
To rebalance things I will take the bit of cash that exists now, and also sell the Australian Leaders Fund (ASX:ALF) holding (which is soon to be restructured and leave the ASX) and add some market exposure. I shall add to the holding in Templeton Global Growth Fund Ltd (ASX:TGG). I can easily see more activism pressure on TGG by the way in 2021. Yet that should take a while to play out, I might write more about that later. For this purpose, I think it will add enough market exposure such that this hypothetical portfolio only needs to be examined again late in 2021. That fulfills the objective to generally just take a glance at it once a year and do nothing, or perhaps one or two changes due to rebalancing / corporate actions. Some cash comes back into the portfolio as CVF completes its wind up in January. With my comments about LICs looking to do SPPs potentially in 2021, such cash might be able to be used opportunistically in those cases also.
Good luck in 2021
As this is my last blog post for the year, I wish all the best for readers here for 2021! I hope it is a lot better than 2020!
Update Feb 10th 2021 – Additional commentary to above post as below issues are relevant to the topic above.
Are WAM Global shares (bonus options) a good investment? (ASX:WGB)
I made a comment above in relation to ASX LIC SPPs “The usual suspects will cite reasons such as increasing liquidity and awareness of the LIC, reducing the fixed costs as a percentage, and great new opportunities to invest the new money.” I implied to show some healthy skepticism with this comment “The reason you will not hear will be because it increases AUM fee revenue for the manager.”
When seeing today that WAM Global were issuing “free” bonus options shares it reminded me of my above points on ASX LICs trying to raise capital.
I can’t obviously offer advice about what to do with your WAM Global shares but it poses some interesting questions.
The purpose of the bonus issue per the announcement was to “increase it’s relevance in the market, improve the prospect of broker and research coverage, and gain additional interest of financial planners”.
Do you think WAM Global is really lacking in the above?
Another reason is “to reduce the fixed expense ratio of the company”.
WAM Global currently is more than $500 million in size, do you think that poses problems for it’s fixed expense ratio?
Would becoming a much larger LIC potentially prevent it from getting set in great smaller opportunities, i.e. do they become less “nimble” with their trading in the future as a result?
Is potentially doubling the size of the supply of units bullish for the price of the asset I own?
Is it a good thing that the balance of profit reserves and franking credits now possibly get shared over a much larger number of shares issued?
If I don’t have the money or willingness to take up my bonus options, will I get a fair price if I have to sell them on market?
Investors who wanted to invest more in WAM Global, has there even been anything stopping them of late given a normal discount to NTA, is a bonus plan necessary?
The announcement mentions they are pleased with the investment performance they have delivered and therefore excited about growing the fund to benefit shareholders. Performance has roughly matched the index BEFORE fees, expenses and taxes. Given their large base fees charged, this means an underperformance to a basic global equities ETF. Is this the time to pat yourself on the back and expand?
Are their enough independent directors on the board with significant skin in the game?
How do ASX LIC bonus options work? How much could options potentially dilute the NTA of my shares?
Lastly here is a few links on the topic of LIC options from over the last 5 years or so.
As always comments welcome! I think my thoughts are different to many on this LIC bonus options issue.
Disclosure – I do not own shares in WAM Global so not complaining from a shareholder’s perspective. So I guess I can not ask such questions at the next AGM. 🙂