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What happens when the axe hits LIC dividends?

ETF Watch - Mar 03, 2017

We almost fell of our chairs on Monday when we saw Listed Investment Company (LIC) Australian Leaders Fund (ALF) fall almost 10% in a single day of trade. ALF is an Absolute Return manager (meaning they can buy stocks as well as short or sell stocks), whose price generally sees much lower fluctuation than the broader market due to its long/short nature. ALF manages around $360m of funds and has fairly decent liquidity, so we knew something was up to see such a large fall in a day and dug a little deeper.

ALF reported their half yearly results on Friday. LIC results tend to be arbitrary type affairs, as investors are generally more concerned with the underlying holdings than the holding fund itself and profits or losses reported are often less to do with the 12 month performance of the fund but capital gains realised through the period, however this was a little different. Buried in the many announcements was the dividend for the period. Investors who checked out the dividends they were to expect may have been surprised by a cut in the final dividend from $0.05 last year to $0.04 (a 20% cut) and the fact that the franked component had been halved from 100% to 50%, the first dividend not fully franked since ALF started paying dividends in 2007.

What happened?

ALF has recently gone through a period of poor performance. Their profit was down 85% for the half year compared to the same period last year, meaning they locked in considerably less gains. This meant the profit reserves did not exist to pay a large dividend. Additionally, lower profit means lower franking credits on offer, and there were not enough franking credit reserves to keep the dividend at 100%. 

ALF being a actively managed fund tends to rely on much of its performance as capital gains, compared to funds like the LIC Grandfathers who tend to buy and hold and rely on receiving dividends for their profits. This tends to make earnings for funds like ALF more susceptible to periods of lower profits or losses.

What’s the lesson?

It’s easy in a low yield environment to get excited by consistent dividends, and their 100% franked nature is the icing on the cake for the many Self Managed Super Fund investors who pay little or no income tax on earnings.

Seeing over 2 million shares change hands on Monday and the share price fall by almost 10% says to us that there were plenty of people shocked by this who headed to the exit doors looking for more consistent yield.

Is this a one off case?

One only needs to go back to 2016 to see $800m manager Djerriwah (DJW) cut their dividend and swiftly go from a 20% premium to NAV to around a 10% premium.

Going back a little further to the bad old days of the GFC saw LIC grandfather, Milton (MLT) cut its dividend in both 2009 and 2010, to 26% below its highs and ARGO (ARG) cut their dividend by 17% over the same period.

During this same period, current market darling WAM Capital (WAM) dropped its dividend by a whopping 75%, from $0.16 per share to $0.04. 

In short, even the oldest and most reliable LICs are prone to dividend cuts at times.

How to protect income earnings from dividend cuts?

There’s a lesson to be learned from ALF’s dividend cuts, and some of the cuts that preceded them. The lesson being that investors should not treat LICs as a guaranteed source of income. However, for investors who are keen to benefit from the mostly consistent franked dividends that LICs offer, some of the things they should be considering are:

  • The profit reserves held by the LIC (reported in their annual reports).
  • Looking for LICs who rely more on dividends rather than capital growth for their profits.
  • Keeping enough cash on hand to be able to manage periods of lower income returns and ride out the volatility.

 

This article is general in nature and should not be considered financial advice. We recommend investors seek professional advice before investing.

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