Picking a winner in listed investment companies
James Dunn | October 07, 2009
Article from: The Australian
Coverage on Restructuring Works' sister site www.Dissolve.com.au
Click here for the follow up roudtable discussion featuring Dissolve's Rod Grosvenor.
SOMETHING is happening in the staid world of listed investment companies.
Known as the tortoises of the sharemarket, LICs compound share price rises and dividend income to generate long-term capital growth.
But activist investors are taking aim at LICs that persistently trade at a discount to their net tangible assets (NTA) figure, the dollar amount that each share would be worth if the portfolio were liquidated.
This year, financial advisory firm Dixon Advisory has led the shake-up of the LIC sector by taking two of the companies in which its clients had invested to task over discounts.
In the first case, Dixons convinced Premium Investors Limited to buy back some of its shares, which has reduced the discount to NTA.
In the second, Dixon requisitioned an extraordinary general meeting of Van Eyk Three Pillars where it removed the chairman and three directors and replaced them with four Dixon executives. The new board is aiming for a substantial share buyback in an attempt to close the discount.
Alan Dixon, managing director of Dixon Advisory, says the firm understands that discounts to NTA are a fact of life in the LIC sector, but describes them as a "double-edged sword".
"We understand that if you go into a closed-end fund, you cannot expect it to tick along like clockwork at NTA or at a premium to NTA," he says.
"A range of 5 per cent either way, even 10 per cent, is a fact of life. If the Australian Foundation Investment Company or Argo Investments (is) trading at a discount, investors love it, because they know they're buying very well and they're picking up an enhanced dividend yield."
If AFIC and Argo were trading at 15per cent discounts, which both have done in the past, Dixon says "our clients and other investors would be licking their lips and that gap wouldn't last very long, because the market has had a very long time to come to trust the track record and management of AFIC and Argo".
But if you're a newer LIC manager, he says, you "have to accept that some people are going to take a large and persistent discount as a very worrying sign".
In that case, Dixon says, investors would rather know they were getting a fair yield and if they needed their capital, they could get its full value.
Dixon says Premium Investors and Van Eyk Three Pillars were "perennially staying" at double-digit discounts to NTA.
"Van Eyk Three Pillars has traded at an average discount of about 15 per cent to NTA this year, and at one point that widened to 22 per cent.
"Premium at one point blew out to a 30 per cent discount," Dixon says.
"We think that once a discount to NTA gets over 10 per cent, the board should be thinking about doing something to fix the problem.
"They can be proactive with initiatives like capital management rather than just wait and hope that the market takes the share price back into the black," he says.
Dominic McCormick, chief investment officer of Select Asset Management, says the stock market "gets LICs wrong more than it gets other investments wrong", because the companies' shareholder base is dominated by retail investors.
"Arguably this is a less efficient part of the market, so I don't think something trading at either a large discount or a premium necessarily reflects the right price.
"Sometimes it is, but more often than not it reflects excessive enthusiasm or disappointment. Some of these deserve to be at a discount; but whether they deserve to be at as large a discount is certainly a valid question."
McCormick says a discount can work in investors' favour. "If you're buying the portfolio at 80c in the dollar and on the dollar it provides a 4 per cent yield, at 80c it provides a 5per cent yield.
"The compounding of reinvestment of that yield will result in a better return, whether the discount narrows or not."
But the LIC sector "needs a shake-up", McCormick says.
"In some cases there really needs to be a greater focus on whose money it really is: it's the shareholders'.
"We've been encouraging boards to be more active from a capital management perspective, doing things that are positive in enhancing returns, and buybacks at a discount will do that.
"Hunter Hall Global Value is one, for example, that has been very active in buying its own shares on-market, at a big discount to NTA."
Whether the buyback narrows the discount or not is not the only game, he says.
"We've done some work recently on the effect of on-market buybacks on actual NTA enhancement or out-performance. It can be quite dramatic. The important thing is that a buyback actually enhances returns. It adds 2per cent to 3 per cent a year, or more, depending on how aggressive the buyback is and at what discount they're buying."
McCormick says there will be increasing pressure on LIC boards, particularly of the newer companies that have listed in the past couple ofyears.
"Some of them have 20 to 25-year management contracts, and that's being highlighted," he says.
"That's clearly a flawed structure, because if there's no sunset clause and they're happy to chug along at a discount accepting management fees, they deserve to be wound up if they'renot prepared to be very active in doing what makes sense for investors. Remember, it is the shareholders' money.
"In an unlisted fund, you can get your money out at NTA whenever, if you're unhappy with the fund's performance.
"In this case, you can't get your money out at NTA, so it makes sense that this sort of corporate activity is starting to happen. We think there'll be more of it."
If an LIC stays persistently at a discount, "it's not worth being in it", says Cliff Sanderson, partner at liquidators Dissolve.com.au.
"It's a simple equation: if an LIC is trading at a 30 per cent discount, sell all the shares, please, and give me back my money," says Sanderson. "I'll reinvest it in the same shares,and I'll make 40 per cent straight away.
"Then if the market goes up 30 per cent from there, I'm getting 30 per cent on my 140 per cent. It seems to me to be pretty compelling maths that they should give the money back in situations like that.
"Anyone who is annoyed with a longstanding discount ought to look at that. If the market doesn't recognise the value, fine, sell the shares. We would not be surprised if there was more activity on this front."
Click here for the follow up roudtable discussion featuring Dissolve's Rod Grosvenor.
