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What’s been happening with LIC Net Asset Value discounts?

ETF Watch - Dec 04, 2018

As we touched on in one on of our last posts, global share markets have quickly moved from bull markets to bear markets over the last few months, with the Australian share market now sitting at 12 month lows. We thought its time to take a look at how LIC Net Asset Values compared to share prices have fared over that time.

Why is LIC Net Asset Value discounts important?

If you’re new to Listed Investment Companies (LICs), one of their unique attributes is their ability to trade away from their underlying value. To provide a simple example, a fund with $1 in underlying assets trading at $1.10 would be trading at a 10% premium to underlying NAV. If it traded at $0.90, it would be trading at a 10% discount to underlying NAV. Some LICs in particular can trade at huge swings to their underlying NAV, meaning an investor’s returns are not only determined by the performance of the fund manager, but also how the fund’s share price tracks to its underlying net asset value.

How have premiums and discounts changed over time?

The below chart shows the average pre-tax Net Asset Value Discounts over the last 5 years. This is against all of the LICs that we track in the ETF Watch database. Some of the LICs have been launched in the last 5 years, others are some of the oldest companies on the ASX. To provide a comparison against broad share market performance, we’ve also included Australians oldest ETF, STW as a comparison, helping to show the difference in premiums and discounts compared to general market movements.

The data shows on aggregate over the last 5 years LICs traded at a pre-tax discount to NAV, in the range of 2% to 7%. On its own, the line does not mean a lot, but when the performance of the STW is overlayed, a mirror image or negative correlation of the two lines begins to appear, where the lines roughly move in opposite directions.

What does this ‘mirror’ correlation mean? Essentially, as markets rise, such as the period from March to August this year, discounts in LIC Net Asset Values increased, meaning the share prices of LICs on aggregate are likely not rising at the same rate as their underlying Net Asset Value. The flipside, in times where markets have fallen, such as September to November this year, the discounts of LICs decreased, meaning the share prices on aggregate are not falling at the same rate as their underlying Net Asset Value. This essentially means that LICs on aggregate do not move at the same rate of volatility than the broad market.

What is the reason for this?

There may be a few ways to explain the above:

  • LIC investors may be more rational than the broad market, not buying and selling irrationally due to short term volatility.
  • The delay in reporting of LIC Net Asset Values (in many cases up to 15 days after the end of the month) means investors don’t have transparency of underlying values so they do not move at the same rate of volatility.
  • The passive nature of holding a LIC means that there’s not the buyers and sellers on any given day to push prices in line with the underlying NAV.

The reality is likely a combination of all the above factors. The underlying message to investors is that when looking to invest in LICs, in times of market turmoil, they may not get the bargain in LICs that they expect. On the flip side, in times of market rises, LICs may represent better value than the market in general.

However, the above does not always hold true.  When we first looked at LIC Net Asset Values (albeit only the 16 largest LICs focusing on Australia), the premium/discount rose and fell reasonably in step with the performance of the broader market. It’s only been the last few years, in a period of reasonably low volatility that we’ve seen this convergence appear.

 

What does this mean for LICs?

The recent market turmoil has seen LIC Net Asset Value discounts hold up reasonably well, with the average discount reducing as markets have fallen. For investors this means that, at least for now, risks of LIC share prices overshooting general market falls appear low. However, it has been 10 years since the last genuine share market crash and many of the new breed of LICs have yet to be tested in true panicked environments. We’ll keep an eye out for how the LIC Net Asset Value discounts fare going forward. In the mean time you can see the latest LIC Net Asset Value premiums and discounts in our fund database.

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