Who would win the Melbourne Cup of LICs? Three of our top picks

Daryl Wilson

Affluence Funds Management

There is nothing like waiting for the first Tuesday of November to come around each year to study the form guide. The form guide for the Melbourne Cup of LICs, of course! We are proud to present our sixth annual form guide for the Affluence LIC Cup.

The LIC Cup is even more important than the Melbourne Cup. Around $220 million was bet on the Melbourne Cup in 2021. But there's approximately $50 billion of investors' money at stake in the LIC sector. And yet, the qualifying field continues to shrink each year, as some LICs retire or leave for greener pastures. And in recent times, there have been a few new runners emerge.

Let's recap 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 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 NTA).

The stewards have been fairly harsh this year. We are not quite sure what they were thinking, but the handicaps they have handed out are certainly bigger than normal on average. This does make it one of the more interesting races in some time.

Track conditions have slowed considerably compared to last year. Even after the recent downpour on the track, there are still more clouds on the horizon. While the ASX200 Index is down only around 5% for the calendar year, the ASX Small Ordinaries and global equities are down closer to 20%. But every wet and heavy track dries out eventually and the race must go on.

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.

And remember - always invest (gamble) responsibly, read the important information at the end of the article, and speak with your financial or other advisers before making any investment decision.

LIC - Starting Handicap - Affluence Form Guide

VGI Partners Global (ASX: VG1) - 20% discount

Talk about flogging a dead horse. When this one first entered the cup a few years ago, there was much anticipation that it would be a front runner. After a promising start, it threw a shoe and has been limping along near the back ever since. Even a recent merger between trainers hasn’t helped, and most investors are now waiting for a stewards’ enquiry to put the horse and punters out of its misery.

VGI Partners Asian Investments (ASX: VG8) - 20% discount

While technically a stablemate to VG1, there has been a change of jockey, which we believe hasn’t been fully appreciated by the punters. The new jockey is one of the best in the country. He will be attempting this year to ride two horses at once. His other charger is trading at par and has done very well. This change has also seen a dramatic change in training strategies. The combination of the new jockey and very favourable handicap could result in a very strong showing.

Ellerston Asian Investments (ASX: EAI) - 15% discount

This horse comes into the race with very poor form. The training strategy centres around racing at the Happy Valley race club in Hong Kong, which has been a tough track to race on for a while now. The trainer stated before last years race that they would offer owners an exit out of the syndicate at NTA, but over a year later, they are still waiting. Frustration is building. It seems the longer this drags on, the worse the horse goes.

NGE Capital (ASX: 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.

Touch Ventures Limited (ASX: TVL) - 50% discount

This time last year, this horse was a punters' darling, trading at a 20-50% premium to NTA. Amazing what can change in a year, with the handicappers now assigning a 50% discount. It’s a roughie, but given the starting handicap, we believe it’s worth a look.

WAM Capital (ASX: WAM) - 20% premium

This trainer knows a thing or two about long races, and is certainly a favourite with the punters. However, a 20%+ premium seems fanciful and highlights the potential danger of backing LICs purely on a dividend yield. 

Perpetual Credit Income Trust (ASX: PCI) - 12% discount

The handicappers have given us a gift on this horse. A very stable runner that rarely misses a stride. Hit with a very generous 12% NTA discount, it looks hard to go wrong backing this one. This horse might not have all-out speed, but you know exactly what you are getting regardless of track conditions.

Hygrovest (ASX: HGV) - 40% discount

One of the smaller horses in the race, and one of the more unusual training techniques. With a focus on cannabis exposure in Canada (for medicinal purposes of course), this horse has been running on three legs for the past year. Given the substantial discount and write-downs to date, this is a roughie that is worth watching. But a recent change in the training regime has us a little worried, and you would be brave to bet on a win.

Magellan Global Fund (ASX: MGF) - 20% discount

This horse has thrown a few jockeys lately, which has understandably spooked the punters. The trainers are scrambling to calm the situation. However, some recent poor runs and unfavourable track conditions have increased the pressure. The stewards have this horse “under review”, so conditions may be tricky for a while longer.

 KKR Credit Income Fund (ASX: KKC)

The handicappers have hit the horse with a very generous weight discount. Perhaps they didn’t realise that the saddlebags (underlying portfolio) had already been lightened. That’s great for punters, as they effectively get a discount on top of a discount. There will be hiccups on a poor track. However, given the two levels of discounts, it’s hard to doubt this horse’s prospects over the course of what is a long race.

NBI Global Income Fund (ASX: NBI) - 15% discount

Another big northern hemisphere trained horse, and another with a generous weight discount. Like KKC, there’s a quality trainer and a discount on a discount. It can be hampered in damp patches of the track, but will come screaming back if it gets a chance on a long dry straight.

WAM Strategic Value (ASX: WAR) - 10% discount

A newish entrant to the field and perhaps the other competitors should be watching their backs. Known as something of a terminator, this wily trainer/jockey has a history of absorbing 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 the jockey is certainly one to watch.

Platinum Capital (ASX: PMC) - 17.5% discount

It wasn’t that long ago when this LIC was hit with a much larger handicap, often racing at a weight premium. Now, it is racing at an all-time high discount (low weight) after a period of poor races. We believe this is mostly due to the track conditions, and the trainer has not forgotten how to win races. With a more suitable track likely in coming years, this is one of the out-and-out favourites for this long race.

Ophir High Conviction Fund (ASX: OPH) - Par

After years of dominating on a lightning-fast track, this horse has stumbled recently and fallen back to the pack. We continue to believe that the trainers are first-rate. However, they are continuing to struggle in current track conditions. The handicappers have taken notice and taken away the large premium. While we believe they should be competitive from here, we think they require a slightly dryer track to do their best work.

Sandon Capital (ASX: SNC) - 10% discount

The recent wet track has caused this horse to stumble along with other trainers at the smaller end of the market. We have a lot of confidence in the trainer and jockey and believe there is excellent value on offer. We believe this LIC is firming as one of the favourites.

Thorney Opportunities (ASX: TOP) - 25%+ discount

This LIC comes from the stable of one of the wealthier trainers in the race. Recent performance has been quite strong, and no doubt, the trainer hopes to keep the momentum going. Not a favourite with either the punters or handicappers, with many put off by the high cost of jockey and trainer. It will need to finish up front to justify the costs. But with such an attractive handicap and excellent pedigree, we believe this is one of the favourites.

Thorney Technologies (ASX: TEK) - 30% discount

Stablemate to TOP above. However, their style could not be more different. This horse focuses on new, technologically advanced training strategies, while TOP continues to be trained behind a tractor. After bolting early a couple of years ago, TEK results came crashing back down when the track conditions got rough. Attractive handicap at a 30% discount, but you must have faith in the new technology strategy to get behind this horse.

Future Generation (ASX: FGX) and Future Generation Global (ASX: FGG) - 10-15% discount

We expected better performance from these two stayers as recent track conditions deteriorated. While longer-term performance has been in line with the pack, the trainer and jockey combinations haven’t delivered as well as expected. There have been some tweaks made to the line-up recently, and they may well put in some stronger runs.

L1 Long Short Fund (ASX: LSF) - 8% discount

One of the best performers over the last couple of years. This is an all-weather thoroughbred and can deliver in a wide range of track conditions. If the prior form is any guide, then it should be a favourite. Their form has attracted attention, and the discount is up to 8%, which will make their race a little tougher than previous years.

Australian Foundation Investment Co (ASX: AFI) - 6% premium

This huge mare and a local favourite is 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 very hard for her to win over a long race. Better odds elsewhere in the pack.

Argo Investments (ASX: ARG) - 3% premium

The second largest horse in the field and one of the oldest, having started racing in 1946. Like a rugby league player in their late 30s, this one doesn’t have the explosive speed it used to, but is a wily old stallion and will run all day. We would be surprised if it wins, but always a solid mid-pack performer.

Tribeca Global Natural Resources Fund (ASX: TGF) - 20% discount

This trainer adopts a niche training strategy. Another one that’s been hurt by a wet track but can recover quickly. Along a full race distance, they could very well be a top performer. The horse has pedigree – it had a big dip in form in 2019 and eventually came back strongly in late 2020.

CD Private Equity Funds 1,2 & 3 ((ASX: CD1), (ASX: CD2), (ASX: CD3)) - 40%+ discount

These US-based LICs are amongst the smallest and least well-known in the race. However, they have been long-term quality performers. They have recently attracted controversy with a proposal by the trainer to withdraw CD1 and CD2 and move all punter money to CD3. 

This led to the handicappers going overboard and assigning a huge 40% plus discount. We are not complaining, as this should help ensure they are lightning-fast from here. In late news, due to an owner revolt, the trainer has backed down on their plan, and all three horses will race. 

Hearts and Minds Investments (ASX: HM1) - 17.5% discount

This time last year, this horse was another market favourite, trading at a reasonable premium to NTA, after some very good performance. Trained by a revolving syndicate of trainers, and got seduced by a new training strategy, which it turned out didn’t perform so well on a wet track. They are now back to more traditional training methods, and we would expect more consistent performance from here. With a pretty reasonable discount, it could be one to watch.

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 the below holdings are currently in our Affluence LIC Fund portfolio.

Thorney Opportunities (ASX: TOP)

We continue to pick TOP, as we believe it offers some of the best value in the field. It has yet to deliver to the extent we had hoped but has outperformed most LICs over the past 12 months.

We often get pushback for owning this LIC due to its unflattering fees and previous poor communication. The manager has substantially improved their communication with current and potential owners, which we believe is a major step forward. The trainer agreement expires in November 2023. We would expect the independent owners’ board to negotiate hard for a better deal.

We have a lot of confidence in the manager to generate above-market returns over the long term. The trainer/jockey is also the largest shareholder in TOP, with a 30% stake.

TOP has been trading at a discount to NTA of 25%-30%, 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 to address the fee shortcomings would also help to reduce the discount, in our view.

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.

CD Private Equity Series (ASX: CD1, CD2, CD3)

This pick is bound to be controversial, as these vehicles are currently not the flavour of the month with the punters. The CD Private Equity Series invest in US Private Equity, and to date, the underlying investments have been managed very successfully by the US-based Cordish family. Performance has been excellent, and the Cordish family are aligned via a substantial co-investment in the underlying portfolio.

The reason for the market distaste appears to be the Responsible Entity, E&P Investments, which has caused some angst among investors due to the performance of other investment products unrelated to the CD Funds.

We have owned the CD Funds successfully over recent years, as the extreme discounts combined with the good underlying performance provided some of the best periodic opportunities we have seen.

The latest flashpoint has occurred as the RE recently put forward a scheme to combine CD1, CD2, CD3 and the unlisted CD4 into a single vehicle, allow it to trade on the ASX for six months, and then transition it to an open-ended, unlisted trust. This has seen an explosion of opposition, leading to the Responsible Entity withdrawing the offer just before the start of the race.

Through this drama, the discounts to NTA have increased above 40%. There is a good chance that the NTAs will be marked down to reflect the falls in US equities. However, to date, the manager has proven to be quite cautious in the valuation methodology as there have been realisations at well above previous valuations. While we continue to be wary of US equity valuations, given the quality of the underlying manager and discount to NTA we believe there is a very wide margin of safety.

NB Global Corporate Income (ASX: NBI) and KKR Credit Income Fund (ASX: KKC)

While NBI and KKC are completely different Listed Investment Trusts, there are quite a number of similarities in their investment strategy and perception by investors.

Both LITs invest in high-yield bonds, mainly in the US and Europe. The majority of the investments are in “junk bonds” (those that either have an investment rating below “investment grade” or are unrated). Most of the time, when the underlying investments and LITs themselves are trading around par we don’t hold these LITs, as we don’t believe the risk-adjusted returns are favourable enough. However, in times of market stress, these LITs have a habit of falling as much or more than equities as the underlying debt instruments trade at a discount to par and the LIT themselves blow out to attractive discounts.

Currently, KKC and NBI are trading on discounts to NTA of 19% and 17% respectively. The underlying portfolios (the debt securities) were trading at a discount to par of approximately 12% and 20%. Therefore, their combined look-through discounts are approximately 29% and 32% respectively. In their monthly report, KKC reported their yield to maturity (annualised return assuming the borrowers fulfill their obligations) of 13.1% and NBI 10.5%. These yields to maturity are before the discounts on the LITs themselves.

So what’s the catch? The underlying debt securities are trading at a discount to par due to credit spreads widening as investors are now demanding a higher risk premium. There is also the added risk of borrower defaults. Look at any historical graph of borrower defaults for high-yield bonds and there are often big spikes in times of economic slowdowns and recessions. This may be exacerbated this cycle, as borrowers are coming off a period of record low-interest rates and the transition to more normal interest costs may cause difficulties for many companies.

Counter to this we would argue two points. Firstly, default rates for the different sectors are always shown at the index level. KKC and NBI are both very experienced credit managers with historical default rates that appear to be well below the index levels. Additionally, they seem to have higher recovery rates for those securities in default. Secondly, at the look-through discount, you can buy these debt securities for, there would need to be an extreme default cycle required to justify the current prices over the medium to long term.

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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