The Australian LIC industry is almost 100 years old and it has experienced many cycles since Whitefield Limited was first incorporated in 1923. The current environment for LICs provides patient and discerning investors with significant opportunities. In 2002, I welcomed a “golden decade” which has extended to almost two decades and 122 LICs and listed investment trusts (LITs) have listed on the ASX during this period.
Evidence that we were approaching the “top” in this cycle included investment managers absorbing listing fees, options ceasing to be attached to initial public offering (IPO) shares and investment managers attaching additional incentives to encourage uptake in new IPO capital raisings. We have seen these “innovations” before.
Notably, during this cycle, fund managers without expertise in managing LICs have chosen to adopt the structure in large numbers. Some have chosen to utilise the closed-end nature of a LIC structure under the false belief that it is “permanent capital”. It is not. Many investment managers have learnt this the hard way as they have either performed poorly over a long period or treated shareholders without their due respect as owners of the LIC, such as conducting capital raisings at a discount to the company’s NTA or by failing to engage with shareholders.
Taking the emotion out of investment decisions
I have been passionate about the LIC structure since reading a mid-nineties Morgan Stanley report that found closed-end funds outperformed open-end funds over a 50-year period. The logic is clear, open-end funds buy and sell in line with investors’ inflows and outflows and this leads to buying when asset prices are high and selling when they are low. Investment managers of a LIC do not face this dynamic and they are able to invest according to their investment process rather than fluctuations in sentiment.
In addition, LICs also have the ability to smooth and grow dividends paid over time and distribute franking credits which can be beneficial to shareholders. Open-end funds like unit trusts must distribute all profits each year, so income is unpredictable.
Buying a dollar for 80 cents
As an investor who is focused on value, I also love the fact that LICs can offer investors the opportunity to invest $1 of assets for 80c and sell $1 of assets for $1.20, as the shares can trade at different values to the reported NTA. Discount opportunities can be realised through events such as a return of capital following a wind-up, or closure of the share price discount over time, as the investment manager or Board of Directors takes action.
I have taken advantage of countless opportunities like these over four decades as a professional investor, Premium Investors, Wealth Defender Equities and Century Australia Investments are just a few examples. The industry cycle plays an important part in these opportunities.
"The average premium/discount across the LIC sector is currently -10.1%. Many of the LICs trading at discounts will cease to exist in coming years and others will see their fortunes reversed. Investors who see the opportunity will be able to benefit as this plays out."
3 measures of performance
The nuances of reporting LIC performance have evaded some newer industry participants and observers. Unlike a managed fund, which can be redeemed at the available unit price, LIC share prices are dictated by the market. Due to this fact, and additional complexities arising from structural differences between trusts and companies, we believe there are three important measures of performance that LIC investors need to assess. These are:
- performance of the investment portfolio versus performance of the benchmark;
- growth in NTA per share and fully franked dividends; and
- total shareholder return.
The first enables a shareholder to assess whether an active manager can outperform on a like-for-like basis with the benchmark, before expenses, fees and taxes.
The second demonstrates the value of that portfolio performance after fees, expenses and taxes and quantifies the impact of capital management decisions (for example, dividends paid, options exercised, new shares issued at a premium or discount to NTA) under the direction of the LIC’s Board of Directors, which can increase or decrease the value of a LIC's NTA separate to the performance of the investment portfolio. The franking credits generated by corporate tax payments, which reduce a LIC's pre-tax NTA when the cash outflow is paid, are available for distribution to shareholders through fully franked dividends.
Finally, total shareholder return measures the tangible value gained by the shareholding measured by dividend income and share price growth. This measure does not value the potential benefit of franking credits distributed to shareholders through fully franked dividends unless it is reported as a ‘grossed up’ figure - we provide this measure to shareholders without the benefit of franking credits distributed.
Every six months Wilson Asset Management provide these three measures of performance together and with context. The ASX recently adopted our method of reporting the reconciliation of the growth in NTA as the industry standard, requiring LICs to report this measure in their annual reports.
To me, there still appear to be examples of LICs which need to address capital management, and need to do more to promptly meet shareholder demands for action to address excessive stock price discounts. Shareholders and their representatives also need to do more in some cases to help the Board recognise the interests of their investors. Investors should hold Directors to account when necessary should they fail to act. A current problem LIC is Tribeca's first LIC, TGF. This has performed very poorly since listing in 2018 and is now trading at a large discount of around 20% to NTA. This is a large discount comparatively, particularly since over a third of the portfolio is in credit (I note that many other credit orientated LICs are trading around NTA). I would like to see TGF take very meaningful and assertive action themselves soon to address this excessive discount. Furthermore, I have personally made clear to TGF's directors and Tribeca's management some actions that they can institute to accomplish this. It can be difficult to justify investing further in any capacity with any investment manager that doesn't act promptly to address issues raised by their investors or their representatives. I am discussing this issue at an LIC panel on Wednesday and will be interested in the views of the broader researcher and consultant community in Australia. In particular, I am interested in whether these investors think one should invest in or support any vehicle of an investment manager - including their unlisted funds - once there is demonstrated poor management of an associated LIC? LICs should never be considered "captured funds" if shareholder interests are to be best served. If shareholders act to ensure that this is not the case, then it shouldn't be.
In a not dissimilar vein, Jerome, Perpetual / PIC did a survey on why people invest in a LICs. Surprise, surprise, inter alia, to get equity exposure managed by professionals. LICs that hold excessive amounts of cash for prolonged periods must look to return that cash to its owners for them to decide.
Looking forward to seeing the universal performance reporting standard (the WAM Group standard) applied across the board for all LIC's annually. A definite win for shareholders far and wide. There is no way 60% of LIC's would voluntarily bring themselves to report the most true/representative performance number in Annual Reports without an insistent ASX standard. The omission of certain fees and expenses, and omission of dilutionary impacts, along with a lack of conformity astounds. There's barely 6 LIC’s that meet the Annual WAM standard with respect to monthly performance reporting today (the AFIC/Whitefield standard). Notwithstanding Whitefield’s perennial discount; one of the factors, that correlates most strongly with whether a LIC (excl. LIT's) trades in the top two quintiles with respect to Discount/Premium, is how transparently and fairly they communicate their performance to shareholders. Those who already apply the AFIC standard for performance reporting on a monthly basis (or WAM Standard Annually), are far far more likely to trade in the top two Quintiles, with respect to Premiums/Discounts (WHF being one of the few exceptions on average, albeit in very recent times graduating itself just into the top quintile). TRUST, of Investors/Advisers; with the manager, strategy, LIC, board and related-parties; are so easily burnt, and so so hard to reclaim once lost. This behavioural-trait speaks to the difficulty many LIC's are having today in fighting their way back to PAR, they've burnt the bridges down. Those Groups that trade at Premium/Par, they clearly don't possess a TRUST deficit. For them, their Trust-Surplus is the deserving reward of exemplary stewardship, the reciprocity that flows from applying the golden rule in their roles as agent, in managing shareholder capital. At the heart of the Discount-dilemma, I believe a meaningful portion of an LIC discount relates to a Trust-deficit. How does a Trust-deficit emerge? For mine, the Truth resides in answering the question who is the BOARD/MANAGER serving? If they are not 100% focussed to serve the interests of the Investor (and by way of one concrete-decision that all LIC’s face) give the investor accurate, fair and representative performance figures; then they are in that specific decision and instance (and likely in many other instances) defeating the shareholder's interest, in favour of their own! Once such a behaviour/standard is figuratively stamped alongside an LIC, it is very hard to shake, because it is truly indicative of the level of Trust you can hold that your interests as a shareholder will receive the priority they deserve. Discount accordingly.
Matt C - hard to disagree with your comments. I use another consideration; any LIC manager that quotes lots of Buffetisms and Mungerisms is one that can be avoided. They are trying to distract from sub-standard performance.
In my opinion, the simplest and most transparent performance reporting would be portfolio performance (after all fees) vs the cheapest ETF that tracks the relevant benchmark (after all fees). This would give investors a transparent picture of whether the active manager was 'worth' the additional cost vs a passive strategy.
Agree Stuart that performance reporting should be standardised to total portfolio performance, net of fees - as opposed to various versions we currently see. Also suggest Geoff may be contributing with total WAM Group regular reporting quoting performance on portfolio invested (which I presume excludes cash, which at times can be a high proportion of portfolio). In my opinion this is misleading.
Noble article Geoff, however your portfolio performances bears little significance for an investor as we don't get that. You should report your NTA PERFORMANCE (like most other LIC's), which is what we get as an investor and it shows the huge fee leakage with your products. You don't report your NTA performance and compare it back to a benchmark to make it obvious for investors. Industry needs to be more transparent for the average investor.