Capital management techniques in LICs
Many capital management techniques are used by LICs in an attempt to narrow or eliminate the discount at which the price trades relative to net tangible assets – all with varying success.
In the last five years, the Australian Listed Investment Company (LIC) sector has grown at a rapid pace to reach a market capitalisation of over $26 billion. The last year alone saw 15 new LIC offerings and total capital raised touching $1.5 billion. LICs continue to be a popular investment choice for investors on the hunt for dividends in an environment where other asset classes have been struggling to provide similar levels of yield.
In October 2014, I wrote an article about why LICs trade at premiums or discounts to net tangible assets (NTA). In the last three years, the overall LIC sector discount to NTA has narrowed significantly, driven by many factors, including the increased popularity of LICs following the introduction of the FOFA (Future of Financial Advice) reforms and the proliferation of SMSFs. There still remains a small part of the sector trading at a discount to their NTAs, and as a result, we have seen the number of capital management initiatives increase compared to previous years.
Two key techniques to narrow the discount
Share buy backs
Share buy backs have had mixed success rates over recent decades. While the technique has worked quickly and effectively for some in narrowing the discount to NTA, it has not been the case for others who have seen their buy back programmes prolonged with no or little narrowing and leading to eventual abandonment of the initiative.
Focusing on more recent times, given the proliferation of LICs in the last few years, uncovers some examples.
Hunter Hall Global Value (ASX: HHV) announced on 27 November 2014 a share buy-back of up to 10% of issued capital. At the date of the announcement, HHV traded at a 9% discount to NTA and had been trading at a discount for the last few years, averaging 16% in the last three years. Five weeks later, the discount to NTA had narrowed to 4%, despite the fact that the company had not started implementing its buy back mechanism. In this case, announcing the buy back on its own seemed to have the desired effect.
Premium Investors (formerly listed on the ASX under the code PRV), a LIC part of the Treasury Group, traded at a discount of 15-25% for many years. It had various buy backs of up to 10% of stock under way over some years, which didn’t narrow the discount to NTA to the Board’s satisfaction. In August 2012, it announced a buy back of up to 75% of stock, citing the discount to NTA over a prolonged period as the main driver. This particular LIC was sub-scale with around $86 million of funds under management and had a sporadic history of paying dividends. WAM Capital Limited merged with Premium Investors on a NTA for NTA basis in December 2012.
Newer but more established LICs trading at a discount to NTA have been providing shareholders with a formal dividend policy and more forward-looking dividend payment information.
In October 2012, two LICs which are part of Perth-based financial services group Euroz Limited, Westoz Investment Company (ASX: WIC) and Ozgrowth Limited (ASX: OZG), announced the payout of a minimum of 50% of realised profits each year and provided dividend guidance for the following two years. Before the announcement, Westoz was trading at a discount to NTA of 36% and Ozgrowth at 34%. This compares to a much narrower discount at the time of writing of 2% at Westoz and 4% at Ozgrowth.
As mentioned, one of the key drivers of the proliferation of the LIC sector is the chase for fully franked dividends and LICs are now becoming more open in providing dividend policies and guidance, which in my opinion will help narrow the discount to NTA.
Funds may liquidate if discounts persist
In the past decade in Australia, we have seen various LICs either wind up or be taken over in M&A transactions, where the discount to NTA has persisted over protracted time periods. The largest incidence of note was Ellerston GEMS Fund which listed in July 2007. It had a proven track record, a strong investment team, a flexible mandate and raised $600 million in the listing. Just over a year later, and despite a strong outperformance of the fund versus the market during the GFC, the discount to NTA widened to a hefty 24%. The company announced that redemption facilities would be put in place for shareholders to realise NTA over a three-year period and that the LIC would be delisted from the ASX. It delisted in November 2011.
Souls Private Equity Limited was a LIC focused, as the name suggests, on the private equity space. In September 2011, parent company, Soul Pattinson (ASX: SOL), made a takeover bid at NTA for the company, which was trading at a 60% discount to NTA prior to the announcement.
Strong demand for LICs but some discounts persist
Even though we are in a ‘golden decade’ for LICs in Australia, some LICs, particularly the smaller ones, continue to trade at a discount to NTA. More recently issued new LICs which are examples of this include NAOS Emerging Opportunities Company Limited (ASX: NCC), trading at a 12% discount to NTA and Acorn Capital Investment Fund Limited (ASX: ACQ), trading at a 15% discount to NTA at time of writing.
Other factors that we consider to be determinants of trading at a premium or discount to NTA are the liquidity of the stock, the level of marketing by the company or by the contracted investment manager and general levels of shareholder engagement such as direct presentations to shareholders, media exposure and other marketing related activities.
No single method always works
While buy backs have had mixed levels of success in narrowing the discount to NTA, there is no clear evidence that it enhances the share price relative to NTA. In more recent times, some LICs have been providing more dividend guidance and there is evidence to suggest that this has worked for those able to follow this route.
Chris Stott is Chief Investment Officer at Wilson Asset Management. His views are general in nature and readers should seek their own professional advice before making any financial decisions. Wilson Asset Management is a major manager of LICs.
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