The Melbourne Cup of LICs — which would be our favourites?

Daryl Wilson

Affluence Funds Management

We'd like to stop doing it, but people keep requesting it. So, this year, we are proud to present our fifth annual form guide for the Affluence LIC Cup.

The LIC Cup is possibly even more important than the Melbourne Cup. There's approximately $55 billion of investors' (hopefully not gamblers') money at stake in the LIC sector, so it's certainly a lot bigger. Despite that, the qualifying field continues to shrink as some LICs retire or leave for greener pastures. And there have been very few new runners emerge.

Let's recap on the rules we use to pick LIC winners. 

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 requires many of the same attributes. 

For an LIC to perform well, they need a great trainer (investment management firm), an opportunistic jockey (the individual portfolio manager responsible for investment decisions), and a favourable weight handicap (starting discount or premium to net tangible assets).

Despite some inconsistency in past years, the stewards seem to have regained their composure this year. Many of the bigger, proven stayers carry a heavyweight (premium), while the smaller unproven runners mostly have much lower handicaps (discounts).

This year, the track is looking lightning fast, with the ASX 200 up 28% for the past 12 months. But as we know, Melbourne weather is very unpredictable. If the good times persist for too long, we start to look for rain on the horizon.

How did we go last year?

We usually do our best work on a wet track. With the ASX200 up so much last year, we would have struggled against such a high bar. Except for one trifecta of LICs that delivered for us in spades. Here's a recap of our key picks for 2020 and how they went.

Thorney Opportunities (TOP): Delivered a semi-respectable return of 14% over the past year but should have done much better. Despite that, we continue to favour this one as a contrarian bet.

VGI Global and VGI Asian (VG1/VG8): A big disappointment for us. Has struggled in the post COVID arena, and some owners have been highly critical of both trainer and jockey. We don't think the jockey has forgotten how to ride, but he has undoubtedly been a little off form. This combination delivered returns of around 13% in the last year. That would be good in a typical year but not compared to markets in the previous 12 months.

CD Funds I, II and III (CD1/CD2/CD3): We said last year that it was hard to think of a more contrarian bet than these three LICs, and they certainly delivered. It's a classic example of what can happen when you get that rare combination of an extreme starting discount (in this case, 40-55%) and outstanding investment performance. They have delivered returns of between 123% and 185% over the past 12 months (average 147% for the three), significantly enhancing our results.

Had you bet on an equal weighting of these six top picks last year, you would have received a return of around 80%. Had you been a bit more conservative (one third in TOP, one third in CD1/2/3 and one third in VG1/8), that would have returned around 58%.

We certainly don't expect that in the coming year. This year's field is possibly the most difficult to pick a winner from since we began. But that won't stop us trying, so here we go…

Who would make the cut?

We have analysed the field of over 100 LICs, and here, in no particular order, are our 24 starters (plus a couple of reserves) for the "Race that Stops the Investing Nation".

Don't feel bad if your favourite "horse" is not on the list. The quality of LIC runners is very high right now. Many more could have made it into the field this year. Feel free to include your suggestions below in the comments.

LIC

Starting Handicap

Affluence Form Guide

NAOS Ex-50 Opportunities (NAC)

20%+ discount

NAC is our pick of the three stablemates (NSC and NAC being the other two). All three use similar training techniques, which has delivered very good long term results. Confusingly, the stewards have them on widely differing handicaps. However, the trainer may have confused the stewards by having a variety of options and convertible instruments outstanding that dilutes the headline NTA (diluted NTA is a 13% discount). NAC gets our nod due to the lowest starting weight. One to watch, but all three are highly concentrated and not for the faint-hearted.

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.

WAM Alternative Assets (WMA)

10% discount

Under the control of a new trainer for a couple of years now, and progress is being made. Handicappers have considered this and reduced the discount, but it is still reasonable. Under the management contract, the trainer has agreed that unless the LIC trades at better than NTA at least three times in the first five years, the owners can vote to wind up the LIC. This provides a tremendous incentive to the trainer and jockey. We believe it will be a solid contender, particularly if the weather turns sour.

PM Capital Asian Opportunities Fund (PAF)

At NTA

Coming into the race, this LIC was well placed with a 15% discount. However, in the last month, two trainers have launched competing bids to take over, which has seen the handicap dramatically increase. Either or both trainers may improve their offer. However, the LIC has sprinted hard to this point and may run out of gas at the top of the home straight.

WAM Capital (WAM), WAM Research (WAX) and WAM Microcap (WMI)

20% premium

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)

5% discount

Not in the best of form, and the owners have had to make some hard decisions on the future of this stayer. Track conditions have not suited this LIC over the past few years. It looks as if it will continue its career on a new track as an exchange-traded managed fund. There is a little upside left, just the outside chance of a late charge.

WAM Leaders (WLE)

5% premium

We still can't work out what the stewards are doing with this one. Stablemates WAX, WAM and WMI continue to be hit with sky-high premiums. WLE is of equal quality yet is 15% relatively cheaper. We think it looks pretty good at this level and expect another strong race this year.

Salter Brothers Emerging Companies (SB2)

30% discount

A new entrant to the race, and probably not one many people have heard of. It has entered the field through the listing of a previously unlisted fund. Not much is known about this newcomer. However, the starting weight looks attractive. Some owners appear to be selling their stakes down now that the horse is in the big leagues, so it might take some time before it settles down.

Tribeca Global Natural Resources Limited (TGF)

15% discount

Recent pace has been incredible, after a rough start in the big time. Track conditions have changed to suit this LIC, and it has been hitting its straps. The handicappers have been very fair with a 15% discount, and TGF is definitely in with a chance.

Benjamin Hornigold (BHD)

Around 25%

This ex-pirate is now under a new trainer, courtesy of an owner revolt. Ex stablemate has not been heard of for some time. It's a tiny horse, and the hefty cost of training means it's going to be hard for this one to make its owners a lot of money. Could surprise over short distances, but unlikely to be able to keep up for the whole race.

WAM Strategic Value (WAR)

5% discount

The newest entrant to the field and perhaps the other competitors should be watching their backs. This wily trainer/jockey has a history of taking over the slower runners in the pack, and sometimes the stewards are called to get involved. It's hard to see how it will have the out and out pace to win. However, there's never a dull moment with this horse, and it's certainly one to watch.

Platinum Capital (PMC)

10% discount

In yesteryear, this LIC was hit with a much larger handicap, often racing at a premium to NTA. However, after a period of softer returns, it has come back to the pack. We believe this is purely down to track conditions and don't for a second think the trainer has forgotten how to make money. If you believe that track conditions could change, this is one of the out and out favourites for this long race.

Ophir High Conviction Fund (OPH)

12% premium

Pure class from this trainer, with a performance history second to none. While we acknowledge their training methods have suited the conditions perfectly in the past few years, they have also performed surprisingly well on a wet track. The only thing holding it back is a very tough handicap.

Sandon Capital (SNC)

15% discount

Strong trainers, strong form, and performance coming into the race has been excellent. A recent discounted capital raising has attracted the handicapper's attention. We believe this LIC is firming as one of the favourites.

Thorney Opportunities (TOP)

25% discount

This LIC comes from the stable of one of the wealthier trainers in the race. Recent form has been pretty dismal, but we don't believe that the trainer has forgotten how to make money. They charge outrageous fees, and investor communication isn't great. The stewards have graced it with a generous 20% discount which is understandable given the performance. Despite that performance, in fact, partly because of it, we still think this LIC is in with a good shot this year.

Global Value Fund (GVF)

Small discount

An Australian horse with a UK trainer and Australian jockey. Consistent performances have seen the stewards hand out a minimal discount as a handicap. Given the relatively heavy weight, this LIC will likely find it hard to win in the short term. However, it runs well on all tracks, and we have no doubt it will continue to be a solid long term performer.

Future Generation (FGX) and Future Generation Global (FGG)

5-10% discount

Brilliant stayers. 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 keep going. Best credentialled combination of trainers and jockeys in the race. The current weight looks favourable for both.

L1 Long Short Fund (LSF)

12% discount

One of the best performers coming into the race. If prior form is any guide, then it should be a favourite. When LSF started racing in the big league, it appeared to throw a shoe early and quickly lost a lot of ground. It has since recovered all that lost ground and then some. Yet it still trades at a reasonable discount. One of our top picks.

Australian Foundation Investment Co (AFI)

8% premium

This huge mare and local favourite seems like she's been around forever. The 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. The handicappers have hit her with a big premium, making it almost impossible for her to win. Better odds elsewhere in the pack.

Regal Investment Fund (RF1)

Slight premium

This trainer has pedigree and an exceptionally strong performance history to match. It runs an unusual strategy of using 5-6 different jockeys, which works very well when the horse has momentum, but can come unstuck badly on a wet track. Currently one of the more popular horses with punters, and can be an exciting ride.

CD Private Equity Funds 1,2 & 3 (CD1, CD2, CD3)

10-25% discount

These US-based LICs are amongst the smallest and least well known in the race. However, recently have been amongst the very best performing. Last year the handicappers went crazy and assigned discounts of up to 50%. For those that got on early, there was easy money to be made, as those light weights made it almost impossible to lose. The discounts are more reasonable now, but still undemanding. We continue to believe they will race very strongly.

Ryder Capital (RYD)

15% discount

A dark horse with a somewhat reclusive trainer, this lesser-known filly has a surprisingly good track record and could well surprise. A good handicap and in with a real chance.

Djerriwarrh Investments (DJW)

Small discount

This smaller stayer has been lagging better known stablemate AFI but has recently started catching up and has some momentum behind it. One to watch and could surprise.

Forager Australian Shares Fund (FOR)

15% discount

Had a surprisingly rough period in 2019, then got belted by the Covid storm. Since then, it has recovered exceedingly well, demonstrating the good pedigree of trainer and jockey. It goes best in fair weather and can continue to surprise to the upside if conditions persist.

Cadence Capital (CDM)

13% discount

Another runner that has hit good form this year, though has come off the boil slightly in recent times. Like many horses we rate, the jockey is a part-owner, which always adds extra incentive to win. A big momentum runner, and if it hits top speed, can be an absolute flyer. Another one to watch.

Perpetual Equities Investment (PIC) and Options (PICOA)

5% discount

From the large and highly regarded Perpetual stable comes this relatively young stayer. Has performed well and has been given a fair handicap by the stewards. On track odds are not great, but interestingly, betting agencies are offering options on its chances in next years race (PICOA). We think that's worth a punt if you know what you're doing.

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 current holdings in our Affluence LIC Fund portfolio.

Thorney Opportunities (ASX code: TOP)

We have picked it before, and it has disappointed. However, like true value investors, we are still going to pick it again.

We often get told all the reasons not to own this LIC; horrendous fee structure (the manager charged $5.8 million in performance fees in FY21 despite being well and truly behind the portfolio value high watermark), below average investor communication, and very average portfolio performance over the last three to five years. We don't dispute any of this.

However, the detractors also ignore a few reasons to own it. The manager is Thorney Holdings, which is owned and managed by Alex Waislitz. Alex is ranked as a billionaire on the latest AFR Rich List, having made his fortune from investing. That is not something to dismiss lightly.

Thorney Holdings is also the largest shareholder in TOP, with a 30% stake. Regardless of the fee shortcomings, the manager is well and truly aligned with long term performance.

TOP has been trading at a discount to NTA of approximately 25%, one of the largest in the LIC sector. We believe this discount leaves plenty of room for improvement if/when underlying portfolio performance improves. 

Any moves by the manager to address the shortcomings noted above would also help to reduce the discount. In particular, the performance fee mechanism whereby the high-water mark is reset regularly is out of line with today's expectations.

Lastly, and most importantly to us, the underlying portfolio includes a selection of unloved value stocks, which we think can perform exceptionally strongly over the next few years. Many value managers have struggled over the past few years, so TOP is not alone.

Platinum Capital (ASX code: PMC)

Value is dead, and growth investing is the only way forward from now on. If you believe that statement, then stop reading now, as this one is not for you. Actually, if you believe that statement, you probably stopped reading a while ago.

At Affluence, we have a bias towards value investing, so PMC resonates easily with us. Medium term performance is lagging the index badly, although their long term track record is still well ahead. We often read reports of investors redeeming their investment from value managers to give to growth managers, in the expectation that the last few years trends will continue forever. 

The performance difference between value and growth is now larger than it has ever been. In growths favour. This either means that it really is different this time and buying high growth names at extreme prices is the only way to invest. 

Or it means that perhaps there is a very strong potential return from a reversion to the mean towards value. We are big believers in reversion to the mean.

Over the medium to long term, we are very comfortable backing the Platinum team on portfolio performance. If markets do correct, their conservative style and long-short strategy should survive with much lower drawdowns. 

Even better, we are owning PMC now at a 10% discount to NTA. Five years ago, it was trading around a 20% premium, so we believe there is reasonable upside if the portfolio performance returns.

Ryder Capital (ASX code: RYD)

Perhaps not an LIC that is widely known, but it has been quietly delivering under the radar. It is towards the smaller end of the spectrum at circa $125 million, but given it invests in smaller stocks, it is sized quite nicely for the strategy.

Portfolio performance since inception has been very good, even when substantial dilution from option exercising is taken into account. Their investment mandate is very wide.

Their portfolio often includes a combination of growth and value names while carrying cash for opportunities. They also have holdings in unlisted positions from time to time, which can add significant value.

The two portfolio managers are the largest shareholders, and at June 21, they controlled over 20% of the LIC.

The headline discount to NTA is currently circa 18%, or closer to 15% if you include the impact of in-the-money call options. The trading price has softened quite a bit over the past 3-6 months, even though performance has been quite strong. This is probably partly due to investors exercising the outstanding options before expiry in December. 

We believe this situation has created an opportunity to buy in at a relatively attractive price. Post-December 2021, when the options expire, we believe the current discount will look very attractive compared to the rest of the market for this calibre of manager.

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, here are some more LIC articles we've done with Livewire:

Take care and all the best with your investing.

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Daryl Wilson
CEO/Portfolio Manager
Affluence Funds Management

Daryl has over 25 years’ experience in finance and investing. He formed Affluence to provide investors with regular income and long-term capital growth by investing with some of the best fund managers available in Australia.

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