This is a guest post from Steve Green. Steve is a full-time investor with a focus on LICs, event-driven and activist investing. You can follow some of his ideas at his investment blog at www.stevegreeny.com
Most investors probably have an inkling that active fund managers are not doing a stellar job when it comes to outperforming the S&P 500 of late. Sometimes a chart is worth a thousand words, and here is one that ought to grab the attention of those with a penchant towards a mean reversion, contrarian and cyclical approach to their investing.
This post will predominately be for those that subscribe to the theory that active managers may be in store for some sort of return to favour over the next few years, and potential implications of this for some LICs.
One theme that surprised me over the last couple of years was the lacklustre rating of some high profile actively managed international LICs, that have clearly proved themselves as being able to outperform over long periods. I place PM Capital & Ellerston Capital in this category. Both had proved themselves as good active managers over long periods, prior to establishing LICs a few years ago. PM Capital have a global LIC (PGF) and an Asia focused LIC (PAF), and the same applies to Ellerston Capital with EGI & EAI respectively. Over the last couple of years, they have all traded at substantial discounts to NTA. If one purely judged them on relative performance during their lives as LICs, perhaps this made some sense. The market seemingly placed very little emphasis that these asset management teams have delivered good results going back now to 15-20-year records in some cases. The below chart outlines the most recent NTA premiums and discounts of the above funds
The opportunity to buy at a very large discount to NTA may have diminished somewhat this year, but I still find it interesting that the market places a larger discount to them compared with many Australian focused LICs. I fully understand their fee structures may be more expensive in some cases, but at the end of the day it is the after fees and taxes return that you have in your pocket. On that front, the returns from PM Capital & Ellerston (assuming we combine their unlisted performance records spanning many years) come out quite attractive.
PM Capital’s long running global product since 1998 has solid absolute returns, despite arguably commencing with headwinds such as expensive US valuations and an Australian dollar in the low 60s. Both these fund manager’s long term unlisted records look even more impressive relative to benchmarks. I concede that the Ellerston LICs don’t have as much of a resemblance to their unlisted products like is the case with PM Capital. They do however draw on many of the proven strengths shown by their investment team over a long period of time.
Another one I could make the same point with is Platinum Asia (PAI). This has often traded at an attractive discount to NTA, strangely even when the Platinum International Fund (PMC) has commanded a premium. Whilst the individual portfolio managers may differ between the two, Platinum Asia has a very good track record when going back and looking at their unlisted product over the long term. If the market’s differing ratings of the Platinum LICs comes down to concern over the Asian region, this would be a little strange given PMC has a large active bet to this region anyway.
This leads me to another observation in the LIC space, where a couple of catalysts often lead to a positive short-term re-rating in the share price. There is nothing groundbreakingly new in me mentioning options expiry and dividends as two potential catalysts, but I thought I would relate it back to some examples with actively managed LICs of late.
I purchased some PAI shares in May this year for $1, which coincided with the expiry of the associated listed options. I estimated they were trading at greater than a 10% discount to NTA. Interestingly, only a month or so later, the NTA had weakened yet the shares had climbed to $1.07. Another small part of the reasons for buying was also that I expected them to announce their first dividend soon.
On some occasions, simply reading through the historical financial reports about matters such as dividend policy, profit reserves, franking credit balances and noting how the underlying portfolio is currently tracking can provide you with a very good guide as to the upcoming dividend. I find that announcing the very first dividend, or a large increase in dividend can provide a short-term boost to the share price.
Another example that springs to mind that I have blogged about in the past is Sandon Capital (SNC). In the second half of 2016 it was evident that the portfolio was performing well, they had plenty of franking credits on hand, and a strong dividend policy. The semi-annual dividend climbing from the 2-cent range to 3-3.5 cent mark personally did not surprise me given their communications. What did surprise me was the share price going from a 15% discount to NTA to a 5% premium. The positive re-rating seemed to gain extra legs around these dividend announcements.
The above themes have been playing on my mind and in part led me to buy the Future Generation Global Fund (FGG) recently. Ahead of it in the shorter term is the options expiry and hopefully a dividend is not too far away. It is a fund of funds approach with a very high-quality list of active managers on board. I like the concept of seeing some money go to charitable causes rather than the fund managers directly. From purely investment considerations though, taking a view that the better active fund managers are likely to be heading for a cyclical period where they may substantially outperform their benchmarks appeals. What also appeals to me is I gain this exposure far cheaper than if I was to try to access these fund managers directly, and if they shoot the lights out my returns will not get deflated from fat performance fees.
In recent times, I had written about comparing many of the Wilson Asset Management LICs. Last year Century Australia (CYA) appealed to me, and this year I felt the new WAM Microcap (WMI) made sense at the IPO price. I realise FGG is not directly managed by the Wilson team, but it was founded by Geoff Wilson. If I had to pick amongst all the Wilson LICs and Future Generation then I would favour FGG from this point, especially at about a 5% discount to NTA where it is at the time of writing and under $1.10 where Geoff has been buying heavily. Any additional weakness occurring in the last month before options expiry may prove to be a timely entry. In that event I would expect the removal of the options overhang to eventually lead to some recovery in the following months, like was witnessed in the PAI example. If my opinion doesn’t amount to much for you, it may be of interest to note the following ASX announcement provided by Geoff Wilson.
Perhaps it is time to at least check up on how much exposure your portfolio has in Australia’s relatively concentrated index. From a currency perspective at least, it may be a better time to do so than compared with a few months ago.
In the cases above the fees you pay will undoubtedly not be the cheapest around. But like most things in life, obtaining the lowest fee products is not certain to offer you the greatest value for money. Because we are in the mature stages of a bull market, I must admit I am not supremely confident of the absolute returns some of these funds can generate going forward in the shorter term. My confidence is high though that the likes of PM Capital, Ellerston, and the Future Generation Funds can outperform their benchmarks in the medium to longer term from today’s levels.
For disclosure purposes, I should note that at the time of writing I own shares in EAI, FGG & PAI, of those mentioned above.