Listed Investment Companies (LICs) have been given a lot of stick lately. Many LICs have traded at substantial discounts to their Net Tangible Assets (NTA), causing much angst for their shareholders. One small LIC – Monash Absolute Investment Company (MA1) - has recently taken the bold move to convert to an Exchange Traded Managed Fund (ETMF). As reported in Morningstar on 10 June 2021, Monash founder and co-portfolio manager Simon Shields said about the discount problem:
“Within two years of its listing, we thought, this is reflecting badly on us. We felt it was besmirching us to be managing a LIC that was trading at a discount and we weren’t prepared to have this situation continue.”
As the manager of a LIC that has been successfully trading at a premium - Plato Income Maximiser (PL8) – we have a different take on LICs. In the absence of a mechanism to arbitrage the difference between NTA and market price, the price of a LIC simply reflects relative supply and demand for the LIC. LICs trading at a discount have more shareholders wanting to sell the company than buy it, simple as that.
Throughout this paper, the same arguments can largely be made for Listed Investment Trusts (LITs).
So, here are five reasons why a LIC may trade at a discount.
1. No raison d’etre
We feel LICs should have clear reason for being, that is, a clear appeal for investors - for investors are the people who buy and sell the LIC. If a LIC is simply a carbon copy of a managed fund, with no special features, and perhaps a more costly fee structure (taking into account listing and directors' fees) then one might question what is the raison d’etre for that LIC.
Our LIC has a clear reason for being. A LIC structure lends itself to banking profits and smoothing income payments across financial years, providing a regular income stream to retirees. PL8 is still to our knowledge the only LIC that pays its shareholders regular monthly fully franked dividends, fulfilling retirees needs for regular income in a time when many traditional income assets can’t even keep pace with inflation.
Other good reasons for a LIC or LIT structure may be to access assets that don’t lend themselves to traditional managed funds or ETFs, such as illiquid assets like real infrastructure, private equity or private debt, or assets that retail investors are less likely to have in their portfolio like small cap or micro cap stocks.
2. Manager greed
Manager greed can take many forms. LICs are a great way of raising permanent capital for the manager but that doesn’t help the investors in those vehicles.
Greed can be reflected in fees. The fee structures of some LICs can be excessive. In my opinion, it’s difficult to justify fee structures in excess of 1% pa, particularly when the company also has to pay for the costs of a listed vehicle. (For comparison, PL8 charges a management fee of 80bp pa + GST).
And many managers also charge performance fees on top of that! Some argue that performance fees align interests, but should not all managers seek to maximise returns for their clients in any case? And they can be aligned by investing in their own funds/LICs/LITs.
Greed can also be reflected in asset size. In the hype and hubris of an IPO campaign, managers might issue more capital than they initially planned, or more than a normal market, not an IPO campaign-influenced market, can bear. Once the hype of the IPO dies away, if there are more sellers than buyers, then the LIC will likely trade at a discount. In this case, a buy-back may help equalise supply and demand.
3. Inadequate size
There is a reasonable amount of evidence that size matters, with bigger LICs more likely to trade at or above NTA. Partly, this may reflect economies of scale in terms of costs. Buying back stock exacerbates the size problem.
4. Poor performance
Whilst its not always the case, company performance is often the reason why LICs trade at a discount, with shareholders wishing to exit an underperforming asset. Trading at a discount then exacerbates the underperformance, causing a potential vicious circle.
The problem is that no manager can outperform all the time, and investment styles like growth or value can have long periods of underperformance. Until recently, value has performed miserably around the world for about 10 years.
Of course, if the manager is just rubbish then the LIC deserves to be trading at a discount, but if it’s purely a matter of style, contrarian investors may use the discount to enter the contrarian asset at an attractive price.
5. Lack of communication
As in all things, communication is also key. LICs and their managers need to clearly communicate with their shareholders, keeping them regularly informed. Lack of communication may also help explain why some LICs trade at a discount to NTA.
Summary
I believe that well-managed, reasonably-sized LICs with a real raison d’etre for investors (not the manager) and reasonable fees should trade pretty close to their NTA over time. For small LICs with little investor appeal and excessive fees, perhaps they may be better off closing or converting to another structure.
Dr Don Hamson is Managing Director at Plato Investment Management. This article is general information and does not consider the circumstances of any investor.