Doug Goodwille from Kayne Anderson speaks to Drew Meredith from The Inside Network on market thinkers.
While a surging gold price is on hold as the world adjusts to a Trump presidency, all the factors that saw its price rise more than 50 per during his first term in office – trade disputes, fiscal deficits and geopolitical tensions – are almost certainly guaranteed the second time around.
LIC sector in need of a health check
As highlighted in this article the Listed Investment Company sector has become a major focus of fund managers and investors alike in recent months.
Last week, Magellan announced that they will be converting their Magellan High Conviction Fund (ASX:MHH) into an active Exchange Traded Fund or ETMF. This comes shortly after the long-standing Monash Absolute Investment Company (ASX:MA1) made a similar decision.
Commenting on the reason behind the change, Simon Shields of Monash noted that “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.”
Both were seemingly caused by the persistent discounts that have afflicted some of the best managers in the industry despite the strong performance of the underlying investments. In fact, inspecting Morningstar’s monthly LIC review, just 16 of the 98 LICs available trade at a premium to their NTA. In this environment, there is little wonder that industry doyen Geoff Wilson launched his WAM Strategic Value strategy almost solely to target these discounts.
It was only natural that one of the more successful proponents of the LIC structure weighed in on the issue, with Dr Don Hamson, founder of Plato Investment Management, a specialist dividend focused Australian equity investor, outlining five reasons behind his own success but also why discounts are so prevalent.
In a poetic way, Hamson leads with the lack of a raison d’etre, French for having aclear reason for being, or in the case of LICs ‘a clear appeal for investors’.
“If an 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.”
He highlights that the most successful LICs have been those leveraging the benefits of the structure, specifically the ability to smooth income. LICs are of course structured as companies, not trusts like traditional managed funds, this means they have retained earnings and are able to continue paying dividends in periods like 2020, despite many of their investments cutting their own dividends.
He also suggests that offering exposure to asset classes that are difficult to access for most retail investors, like private debt, infrastructure or private equity could also be popular.
Greed
“Manager greed can take many forms”, Hamson says, referring to the permanent nature of capital that comes with LICs. By this, he means that because an LIC is a closed end company, new shares are rarely issued nor are old shares removed as they would be in a trust. Therefore, the capital raised at float, remains the capital available to invested, the pool is therefore trapped in the structure.
In his 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”.
“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……Once the hype of the IPO dies away, if there are more sellers than buyers, then the LIC will likely trade at a discount”.
Size matters
History suggests that size is incredibly important in the world of LICs with bigger LICS more likely to trade above their NTA, whether due to greater liquidity or economies of scale for the issuer.
Underperformance
Naturally, one of the most common but potentially ignore reasons for trading at a discount, is the underperformance of the underlying manager and their portfolio. Investors naturally flock to the exit and any market with more sellers than buyers is always heading lower. “Trading at a discount then exacerbates the underperformance, causing a potential vicious circle” he concludes.
Investors Relations
As is the case with every business from Telstra to Berkshire Hathaway, ‘communication is key’ says Hamson. “LICs need to clearly communicate with their shareholders, keeping them regularly informed’ which should also deliver greater engagement.
From my perspective, the future is clearly moving towards the dual structure being pursued by the likes of Magellan, by virtue of its ability to offer the best of both worlds. Direct investors can trade on their preferred stock broking system, whilst the advisory market can access these products without extensive administration paperwork.
The big question may well be where the future of platforms lies in a world where every fund is available as an ETMF, even if that may be a very long time away.
