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Market pricing of listed investment companies (LIC) can be a weird science. A LIC trades on a persistent, large discount to the value of its underlying portfolio for no good reason.
LIC bulls promote this as an opportunity – when a LIC that trades at a 20% discount to its pre-tax net tangible assets (NTA), investors in theory are buying $1 of assets for 80 cents.
If only it was that simple. Some LICs trade at big discounts to NTA because they have poor underlying performance, or the market has concerns about management. Or the LIC has a patchy dividend record, invests in an out-of-favour sector or has many options issued.
Low liquidity in small LICs is another factor. As with other thinly traded stocks, lack of regular buying and selling creates pricing anomalies. Poor investor relations programs from smaller LICs, usually because of their tight cost structures, can also hinder their share turnover.
So, care is needed in buying LICs based on discount to NTA. Still, I’d rather buy a LIC trading near or below NTA than one trading at a double-digit premium to its asset base. Paying more for an asset than it is worth, no matter how good the asset manager, is rarely a good idea.
First, don’t rely solely on the latest published NTA, or dated LIC discount/premium data. The Australian Securities Exchange (ASX) requires LICs to publish their NTA per share within 14 days from month’s end. If the share market has fallen during that period, there’s a good chance the LIC’s NTA is a little lower too.
Second, focus on pre- rather than post-tax NTA. The latter factors in all tax, realised or unrealised and shows the portfolio’s value, if all positions were exited. But unrealised gains in part of the LIC’s portfolio may take years to be realised, meaning the tax impact is a long way off.
Third, do not look at a LIC’s discount/premium in isolation. Compare it to the LIC’s long-term average on this metric through a cycle (5-7 years). LIC discounts and premiums have a habit of reverting to that average; for example, a LIC that has traded at a slight discount to NTA over many years could be undervalued if it is suddenly trading at a 10% discount.
That approach is trickier with LICs that do not have as much trading history to go on. Many LICs have come to market in the past few years through Initial Public Offerings (IPOs). But the core concept of comparing a LIC’s premium or discount to its longer-run average has merit.
The fourth rule is all the usual checks with a managed fund, listed or unlisted. Is the fund well run? How does its performance rate? What is its investment style? And what are its core stock holdings and fees? And in the case of LICs, what is the dividend and franking history?
If you find a quality LIC with good underlying performance – trading at a discount in excess of historic norms – you might have uncovered a mispriced bargain.
There were 17 LICs that invest in small- or mid-cap stocks at June 2018, ASX data shows. Only a few LICs in this category, mostly from the well-performing Wilson Asset Management stable, traded at a premium.
The discount to NTA in some of these LICs has expanded over the past 12 months, despite the broader market’s solid gains in this period. It’s a tough time to be a small-cap LIC manager.
I suspect part of the problem is the investment style of several small-cap LICs. As value investors, they’ve been caught up by the market’s infatuation with momentum plays, such as tech stocks or China-focused agricultural companies that have soared to dizzying heights.
Whatever the case, small-cap LICs traded at a median discount to NTA of 11% at June 2018, using ASX data. A handful traded at or above a 20% discount to NTA. With a few exceptions, small-cap LICs collectively look as unloved as they have in a while.
That’s despite the S&P/ASX Small Ordinaries index delivering a total return (assuming dividend reinvestment) of 23% over one year, versus 14.4% for the S&P/ASX 200. The S&P Mid-cap 50 index is also just ahead of the S&P/ASX 200.
The market, it seems, has forgotten about some small-cap LICs on the ASX. As with all micro-caps stocks, these LICs suit experienced investors who understand the risks of investing in this part of the market.
Glennon is trading at a 14% discount to NTA after a share-price rally in the past few months.
The Glennon Small Companies portfolio has consistently outperformed the Small Ords Accumulation Index since 2008 and the gap has widened in the past few years. The fund has done well recently from holdings in Emeco Holdings, Afterpay Touch Group, Titomic, BWX and CML Group.
Like most LIC IPOs, the Glennon LIC has traded at a persistent discount to NTA. Directors have been buying shares, always a good sign, and the management team has expanded. The LIC has a good portfolio and a nimble investment style that is suited to this market.
The gap between the NTA and share price should narrow if Glennon can maintain its recent fund performance.
Listed in 2014, Barrack St is another small-cap LIC trading at a discount to NTA. The 94-cent share price compares to the latest stated NTA of $1.18 – a 20% discount.
Barrack St’s underlying portfolio has returned an annualised 12.8% since inception in January 2014 versus 2.9% for the All Ordinaries index (before fees). The portfolio is up 20% over one year or just over double that of the All Ords.
Unlike several of its peer LICs, Barrack St tends to invest in higher quality companies. Magellan Financial Group, Pendal Group, Carsales.com, Seek, Domino’s Pizza Enterprises, Corporate Travel, IPH and Reliance Worldwide are its top holdings.
The LIC has added fintech stocks, such as Afterpay Touch Group and Pushpay Holdings, to its portfolio this year, possibly adding a bit more momentum to portfolio performance.
It’s hard to know why a LIC whose portfolio has outperformed the market trades at such a large discount to NTA. My guess is Barrack St needs to lift its investor relations– crucial for all LICs – to capture market attention. National roadshows to investors this year are a good start.
The LIC is unusual by ASX standards: it invests in unlisted “growth stage” technology companies that have proven business models and are scaling their opportunity. Bailador is a bit like a listed venture capital fund that takes investment stakes – and board positions – in privately owned tech companies.
The LIC gives investors exposure to established tech companies before they list on exchanges – often a sweet spot where the real money is made for early investors. But private tech companies are hard to value and that probably affects the market’s view of Bailador’s assets.
Like other micro-cap LICs, Bailador also suffers from low liquidity and a low market profile, even though it has put together a promising portfolio of tech companies. Also, investors need to be prepared to hold private tech companies for several years as they develop.
Bailador traded at a 25% discount to its latest stated pre-tax NTA of $1.11. A write-down in one of its investments last year weighed on NTA, but the discount looks excessive.
Bailador’s focus on software-as-a-service companies is timely and the tech stocks are in demand. The LIC has one IPO planned for 2018 (Straker Translations) – an event that could unlock significant value in the portfolio and refocus the market on Bailador.
I’ve liked this LIC for some time, but its NTA growth has disappointed and the share price has fallen. The next 12 months could be pivotal with one or possibly two Bailador investments listing on the ASX, boosting the portfolio NTA and share price.