This article is for entertainment purposes only and is not intended as investment or financial advice. I am not a licensed financial advisor or professional investor. Make sure you seek personal and professional advice before making any investment decision. Read my full disclaimer.
You can read Part I, my brief primer on Listed Investment Company (LIC) investing if you want a bit of background on LIC’s.
This post is more or less an outline of how I select and analyse LIC’s. It’s by no means the only way to do so, but I find it’s pretty efficient at quickly distilling the large number of LIC’s on the market down to a reasonable, quality short list for further analysis.
You can find a comprehensive list of LIC’s traded on the ASX updated monthly by Morningstar here. It contains their NTA, MER and any discount to their NTA as at the time of publication. This is a nice list of LIC’s to go ‘fishing’ in.
Investing in LIC’s
If you’re interested in adding an LIC to your portfolio then that’s awesome. I’m getting excited for you just thinking about it!
Before you buy or sell and LIC, it’s a very good idea to talk to your financial advisor or an investment professional.
These 8 straightforward steps are the ones I use to get a decent grasp of any LIC on the Australian Stock Exchange. You might find them helpful too. The steps should generally apply to internationally listed LIC’s, but these sometimes go by other names, for example, ‘Investment Trust’ or ‘Listed Investment Trust’.
1. Answer the following questions.
- What’s the maximum management fee I’m willing to pay? I like to check the management and performance fee, and the total Management Expense Ratio (the total fee or MER). In comparison to a passive index fund, like the Vanguard or iShares ETF’s these vary widely. My personal preference is < 1.0% p.a. for an active fund and < 0.20% p.a. for a more passive LIC. As a reference, Vanguard charge 0.14% p.a. for their Australian Shares ETF. For an LIC with a 10 year track record of outperformance, I’m happy paying around 1.2% p.a. but only if I can buy the LIC at a discount to NTA, which is rare when the portfolio outperforms.
- Is there a particular sector, region or theme I want exposure to? If it’s simply diversification or outsourcing stock selection, many will be attractive. If you want to invest in small cap Australian shares or international equities, then you’ll need to be more selective. Morningstar issue a monthly report of all Australian LIC’s. In the report you can see the broad LIC type (e.g. Aussie shares, International Shares, Private Equity, Specialist, Infrastructure or Absolute Return), the MER, underlying benchmark, NTA and current discount and market cap (small market cap LIC’s will be less liquid). The Morningstar report is a month old (so end of January results are released at the end of February) but are a very decent starting place.
2. Create a short-list
Based on the criteria from the above I create a short list and visit their parent website. I usually use the MER and discount to NTA as my primary markers initially since there is no record of past performance on the Morningstar report. Overtime, you can make your way through the entire list and make note of the LIC’s of interest to you.
You might also find suggestions from news or magazine articles, broker reports, blog posts or forums etc. but if you use these sources, doing your own research becomes essential. As you get more familiar with LIC’s, you’ll come to know the ones you like and can use the Morningstar report as a ‘screen’ for any discount to NTA etc. I enjoy brewing a fresh cup of coffee and going through the report, looking for any bargains in my favourite LIC’s each month.
3. Check and compare the following – this data is usually on the company website or in the Morningstar report. If you’re a nerd like me you might create a spreadsheet and enter the data or a few comments, otherwise, paper and pen is fine!
- Is there a DRP? If you want to enrol in a Dividend Reinvestment Plan, check for this now. If it’s a deal breaker for you, simply move on. Note down if the DRP provides any kind of discount to NTA or share price. I don’t use a DRP on any of my investments so this is an easy step for me!
- Fees – check the performance, base fee and total MER. These should be the same as in the Morningstar report. The Indirect Cost Ratio (ICR) is usually on the company website.
- Market Cap – You want a fund that is reasonably liquid (well traded). You can double check this by examining historical volume traded per day in you brokerage account or via Google or Yahoo Finance. If you’re keen to buy a large block of an illiquid LIC (e.g. $50,000AUD +) call the company directly and ask if they can help you out. They may make a block of shares available to you.
- Listing date – the date the LIC listed on the ASX. New LIC’s naturally have no long performance record, so it can be useful to look at management’s prior performance (e.g. if they managed funds elsewhere try and track down the funds past performance when under their management). Older LIC’s will have a useful record on show. Checking the listing date is a good idea as it tells you the time frame the ‘% p.a. performance since inception’ occurred over.
- Track record – look at performance since inception and over 3, 5 and 10 years. Checking out the prior 1 year performance can help explain an unusual discount or premium to NTA (e.g. a particularly good or poor year might distort the share price vs NTA, sometimes quite quickly and irrationally) but its not enough to look at this an assume management will achieve a good return consistently. Of course, historic returns don’t guarantee or imply future returns but if a manager has an average 10 year track record, I’ll stay away. Ideally I like an LIC to have outperformed the underlying benchmark or index over 5-10 years by at least 2% net of fees. My preference is for 4% out performance p.a. after fees.
- (Bonus points) Investment Philosophy – does management’s approach seem reasonable to you? Are they high turnover, buy and hold, value, momentum, special situation etc? I’m always wary of “black box” formulae.
Many investors are interested in Dividend Yield, and if this is an important metric to you, add it in! You might also want to consider franking credits or grossed up yield in your analysis.
4. At this point it’s a good idea to read the PDS. I always read the PDS prior to buying an LIC (coffee required). At the end of the day, if I’m not satisfied at this point, I’ll simply wait. There is no point making a sub-par investment, just because, well, FOMO.
5. Calculating the discount/premium to NTA.
We need the following bits of info:
- Current share price of the LIC
- Current NTA (the latest will be on the website, or published in their monthly reports).For funds that tend to hold their investments over a long time and manage the portfolio with an investors tax requirements in mind (e.g. AFIC), Clime Capital have suggested pre tax NTA or using a hybrid NTA, taken as the NTA between pre and post tax NTA. For more actively managed funds (e.g. Wilson Asset Management, Cadence Capital) they suggest using post tax NTA.
- Calculate the current discount or premium to NTA using the formula: discount/premium = (Share Price – NTA) / NTA. A negative value represents a discount, positive value a premium. I don’t mind paying a small premium, but only if I’m satisfied the benefit is worth the cost (e.g. management outperform).
- Trying to understand why the premium or discount exists and if it will eventually disappear. LIC’s with a good track record often trade at a premium and those with a poor track record often trade at a discount, which may persist for months and even years. Sometimes LIC’s trade at a discount to NTA temporarily, because they’re new or for some other fairly benign reason. I do a bit of thinking and see if I can’t figure this out – sometimes it means you might be able to buy the basket of shares for a discount to their current market price.
- Seek a decent discount where possible. My preference is a discount of 10 x the Management Expense Ratio (MER). For example, if an LIC has an MER of 1% p.a., a discount to NTA of (1% x 10) = 10% is quite attractive, all else being equal. e.g. if the NTA is $1.42 per share and the MER is 0.5% I’d consider buying it at a 5% discount to NTA or around $1.35 per share.
In this example, Templeton Global Growth Fund (TGG:AU) was trading at a 10.74% discount compared to its September 30th 2017 price. Since TGG typically uses a buy-and-hold approach, we will use the average of the pre-tax NTA and post-tax NTA, as suggested by Clime. By sheer luck, these turn out to be have the same value ($1.49) and indicate the fund had few tax obligations at the time of the report.
6. Making a buy decision… If I’m happy with the price and satisfied with the research done then adding the LIC to the portfolio is a real option. TGG has always traded at a discount to NTA, so the 10.74% discount doesn’t necessarily indicate a bargain, but the long term discount doesn’t mean you should strike it off your list. The management expense ratio is 1.20% so ideally a discount of 12% is needed for me to consider TGG an attractively priced LIC.
I tend to put LIC’s into a “LIC watch-list” and compare the NTA and price on some regular basis and try to be patient. The price you pay will determine the return you get!
7. If you own an LIC you can decide whether to enrol in the DRP. Instructions for how to do this are usually on the LIC or parent companies website. I almost never enrol in DRP’s but that’s only because I prefer to make the capital allocation decisions.
8. The last step is super basic, I Check back in from time to time and see if I’m still happy to continue holding. For example, you could ask yourself if management are still aligned with shareholders, are fees reasonable and has performance been satisfactory over a decent time period (e.g. 3+ years).
I hope you enjoyed this article! Please let me know what you think and if you have any experience or suggestions of your own, add them in the comments below!