A checklist for buying ASX Listed Investment Companies (LICs) shares
A list of 10 factors to check as a guide when to buy, scroll down for further explanations on each. (Written first a few years ago but still relevant for ASX LICs in 2021 & 2022 I feel!).
1) Discount / Premium to NTA
2) Management Expenses and ALL other costs
3) Performance Track Record
4) Investment Style
5) Alignment of management’s interest with shareholders
6) Ownership Structure
7) Investment Management Agreement (IMA)
8) Size of the LIC
9) Future Dividend Capacity
10) Marketing / Reporting of the LIC
When I look back at my investing mistakes, one common theme is rushing into a new purchase. I find I have usually done better when a number of months pass until I begin accumulating a position in a new idea.
When investing in LICs I try to make sure I have considered numerous factors first. That helps me avoid getting itchy fingers and hitting the buy button quickly.
I’ve seen some similar lists around but I thought others may find it useful to share my perspective. Being an investor for a living with a focus on deep value investing, hopefully I have introduced some different thinking to the topic.
I have less experience investing in closed end funds on the New York and London exchanges. From my observations though this list also looks relevant to CEFs in general.
If you have suffered from decision regret after rushing in to buy a LIC before (I know I have!), perhaps you can bookmark this page. Keep the list handy to check before hitting the buy button. Please share your comments as I am sure other perspectives can also help and improve the list.
ASX LICs surge in supply from commissions conflict of interest?
As we are a few years past a flurry of LIC issuance I also observe some ones with some pretty ordinary early performance. Hindsight is wonderful of course, but with LICs such as HML, MA1, FPC, 8EC, LSF, BAF, CIE etc., perhaps a checklist like this would have given some food for thought. How many red flags could we have perhaps spotted from a basic checklist? ASX LICs have been popular with the SMSF sector, dividend investing blogs and those embracing the Peter Thornhill investing style, so it is important to also be aware of potential traps.
ASX LIC comparison – checklist of 10 key factors as a how to buy LIC shares in Australia
Hopefully this can help avoid the traps out there!
1) Discount / Premium to NTA.
- All things being equal a discount preferred, but either may be warranted depending on factors coming up in the next points. Take account of the pre and post-tax measures.
- Apply extra caution if buying at a premium. I very rarely do so. Don’t buy at IPO is another good rule of thumb.
2) Management Expenses and ALL other costs.
- Base fee but ALSO performance fees. Is the performance fee based off a fair benchmark?
- Have you considered other costs such as administration fees, director’s fees, accounting fees etc that could potentially more than double your overall fees?
3) Performance Track Record.
- Is it based off the long term, including through a bear market?
- Is it recorded correctly? Some LICs can be “creative” and make calculations before various fees and impact of dilutive share raisings.
4) Investment Style.
- For example are they running a deep value strategy that has failed to keep pace during the current era? Are they picking small cap stocks in an environment that has lagged large cap indices? The current style in vogue may make the manager look worse than they are over shorter time frames. Conversely it may flatter certain fund managers. Try to maintain a long term focus.
- Make sure the asset class and style fits in with your current portfolio.
5) Alignment of management’s interest with shareholders.
- Do they have a history of raising shares on issue? Does this occur to boost management’s AUM revenue whilst diluting NTA value for shareholders?
- Are there any options outstanding on the LIC that could dilute the NTA in the future?
6) Ownership Structure
- Related to the management alignment issue, do management own a large blocking stake, e.g. up to 20% of the shares?
- Does this make them happy to see shareholder returns high? Or is this used to keep management AUM revenue high, which could come at the expense of shareholder returns?
7) Investment Management Agreement (IMA).
- Some can leave you “trapped” in the LIC for a decade, and have expensive break fees.
- On the other hand if there are no barriers here, buying at a large discount to NTA could see one benefit from a decision to wind up the company.
8) Size of the LIC.
- LICs well under the $100 million mark may suffer from fixed costs being high as a percentage of the business. Liquidity of the shares may be low.
- However LICs managing billions may be inflexible. Are the trading LICs too large to move in and out of stocks? Do the investing LICs retain old large stock positions to avoid paying tax, leaving them in poor performing mature businesses?
9) Future Dividend Capacity
- Don’t get overly fixated on historic yields, if dividends are cut this could see an adverse share price reaction.
- Examine profit reserves, available franking credits, & current / future potential investment performance. An improving dividend picture in the future can sometimes cause a large positive share price reaction. Look forward more than you look back in the rear vision mirror.
10) Marketing / Reporting of the LIC.
- LICs that make minimal effort with the information they give out in monthly NTA releases can trade cheaper as a result.
- Also if there is no effort to occasionally engage with the financial media then it may be more likely to trade at a discount to NTA in the future.
Hope this helps!
11) Does the LIC have a pirate themed name?
Are ASX LICs a good investment?
ASX LICs of the more “active” variety might be a good hunting ground when they drift out to discounts to NTA of circa 20%. If you analyze the above factors, there could be scope to outperform the market. However I would be very cautious about buying the actively managed LICs and just sitting on them very long term when paying NTA or premiums. Fees, costs, dilution from fund managers with questionable shareholder alignment will eat away at returns. Low fee LICs like AFIC and Argo are a different story, where the low MER suits longer term holding. However these larger more passive LICs have recently struggled to beat the market.
Additional notes regarding point 3 above and “creative” performance reporting from LICs.
OTHER ARTICLES ON THE LIC PERFORMANCE REPORTING TOPIC.
https://cuffelinks.com.au/lic-performance-reporting-inadequate/
https://cuffelinks.com.au/trust-why-not-all-lics-created-equally/
Good list Steve, I might also add under “investment style” or as a separate point, what is the underlying the fund is invested in? For a lot of LICs it is just equities (maybe with shorting) but these days we’re seeing a greater variety hitting the market like MXT, NBI or TGF. We might also see a jumbo private equity one with Pengana’s target offering. I’d argue the underlying can contribute quite a lot to how well it’s received by investors.
That is a good point to bring up and been on my mind of late. If the offering brings something new to the table it may help it trade near NTA or at a premium. I can find examples where the scarcity factor seems to be helping. After all the target market is arguably SMSF investors to a large extent that may need extra diversification.
Having said that I’m a bit skeptical whether some will trade so well in a few years time. Ultimately the investment returns will be the key factor and some new investment thematic LICs still have quite high fees.
URB, BTI, TEK, BAF generally started off ok enough with their unique offerings but after a bit of time the shiny new scarcity factor can wear off. Admittedly these may not be good examples as the the 3 you mentioned had relatively defensive strategies. But the ones I pointed out still marketed themselves as being quite different to traditional equity LICs.
I haven’t had a close look at MXT & NBI though to be honest so couldn’t comment yet whether their fees look reasonably fair or not.
I’d be very curious to see how the debt offerings (MXT, NBI) track over longer term. NBI is in high yield bonds (red flag red flag) so you’d expect the underlying to sell off in the next proper market correction whereas MXT benefits from having unlisted debt (mark to market what?). Both have that attractive monthly distribution profile that I think appeals to the SMSF crowd (PL8 does too subject to Labor potentially crushing it)
My concern would be that too many who took up these IPOs wouldn’t have a deep understanding of what they have invested in. Therefore upon any sign of weak performance in the NTA may be quick to hit the sell button, even at a sizeable discount.
There’s so many factors that are important. It may need to be a top 20 list.
Its your list but some others that we have likely talked about previously are:
illiquidity.
Regardless of size can make getting in or out complicated. Small trades can move LICs by more than 5% sometimes. Tempting, but also risky as the market price can easily be distorted. Daily volume is the indicator of liquidity.
Strategy instability.
A new chief investment officer often signals a change in performance as does major turnover at the investment analyst level. Changes in strategy are often a flag. The best LICs stick to a proven process even when they are having a down year or two.
Over concentration.
LICs with more than 9 or 10 per cent in one holding tend to follow the fortunes of that single holding. Most investors don’t want to be tied too closely to single stocks that have a high risk of falling 30-40% at any time LICs with very concentrated holdings negate diversification efforts and are not great for consistent long term performance.
Superseded and inferior copies.
Perhaps another fund provides extremely similar exposure but consistently performs better. This can happen because structural issues (dominant shareholders, overheads, culture, inertia etc) mean it is a laggard and not interested in change. Better to have LICs with relatively unique portfolio that don’t follow the herd.
Position in its performance cycle.
Investor behaviour is naturally geared towards performance chasing. The worst time to enter a fund is after a sustained period of outperformance. Better to wait a year or two and buy during (ONE) a consolidation after a fall, or (TWO) after the consolidation and a recovery is in full swing. (THREE) Dip-buying can also be opportune if the fund has no problems but is sold off only as a result of an overly pessimistic market environment.
Asset Class.
I agree with the comment by @luxetscientia that ‘Asset Class’ needs its own item to consider the unique risk profiles related to listed/unlisted, cap size, sector, geography, commodities, precious metals and credit. This is important and separate from investment styles to do with growth, value, activist, momentum, quality, long/short, options and futures.
Capital Management.
Usually, consider buy backs as supportive of price and capital raising as suppressants.
Thanks John for adding to the list. Agree that it could be even bigger. At first my aim was to keep it brief as I thought many were picking out some dogs without considering some factors at all. Often doing this at IPO or shortly after. It shouldn’t be hard to screen out a few traps from a quick checklist.
Your point about concentration has changed my views over time. I agree with what you say and think there is usually s bit of a limit on how well these trade. If a LIC likes to sometimes have 10% plus in a single stock I almost expect a permanent sizeable discount to NTA.
On concentration, It was actually something you said on another medium that crystallised it for me as has my recent close-call with CDM and its ARQ concentration.
On buy-backs, will it help if there is a time limit in which a company must buy the shares? If the company does not intend to buy shares then it should let the market know.
Hi Mr D,
The way the rules work now is a large portion of buyback announcements will be for signalling an intention to acquire up to 10% of the company on market within the next 12 months. So there kind of is a time limit in place, but obviously refers to just when they can as opposed to they must buy back a certain %. Once that 12 months is up though it is common to simply make another announcement for a further 12 months.
I don’t think it works if we say they must buy the shares by a certain time because we don’t know the on market liquidity. For LICs the buyback needs to be prudent, so we don’t want them buying above NTA for example.
I’m not sure how to fix the issue of some companies announcing such an intention when potentially that intention is extremely weak.
A far more common practice overseas with closed end funds is to announce more precise on or off market buybacks. For example, if the NTA trades at an average discount of 15% in 2019 we will tender to buy 10% off market at a price of 98% of NTA. Or many different precise variations. I think a small LIC in IBC have done that here.
If the company doesn’t really intend to buy the shares back then if they are honest about that then there is no point announcing the buyback in the first place. Some companies (not all of course), like the idea of letting the market think they will support the share price without the need to actually do it. Hopefully the announcement helps confidence and they don’t have to follow through.
By the way though my suspicion that NSC may flow through with very little of their buyback so far looks wrong.
Thanks for that explanation. I personally have benefited from share by backs but mostly in US market. I’m all for it as long as it does not get too much out of hand.
Yeah it’s hard to generalise. It works well then they buy the shares cheaply.
For the entire market on average though, many have the opinion that management usually does it at the wrong time. Theory that rising number of buybacks is another small signal that markets may be nearing a peak.
When did buybacks bottom out in the US? Hit a low in 2009! About 80% less than management were using them in 2007!