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Pressure rises on underperforming LICs as discounts persist

2019 has been a tough year for LICs, with most failing to outperform their benchmark. We take a look at some of the pressures on LICs in 2019 and how they performed.

By ETF Watch - Dec 04, 2019

The period of 2014 to 2018 may be seen as the golden age for LICs. With over 50 LICs launched during the period, most raising many hundreds of millions of dollars. Fund managers scrambled during this period to turn their products into listed companies.

2019 may be seen as their year of reckoning. Whilst 8 new LICs (and LITs) have launched, most are focused on the fixed income sector, where due to the illiquid nature of this type of investment, the LIT structure has clear advantages.

The sector at a whole however has seen Net Asset Values move from Premium to discount, LICs close and pressure heat up on underperforming LICs.

LIC closures

There’s been a bunch of closures to LICs this year, either due to mergers of LICs with other LICs, conversion to unlisted managed funds or closure and return of capital to investors. In most cases, performance is the key driver in the decisions to close.

We’ve seen Watermark funds management convert their international and market neutral LICs into unlisted investment trusts. Both LICs traded at significant discounts to their Net Asset Values (NAVs) and ultimately investor pressure caused the conversion to unlisted funds, where investors can access their capital at the NAV.

Serial activist Wilson Asset Management, after taking over management of Century Australia Investments a couple of years ago, finally was able to close the fund and move it into their WAM Leaders Fund (WLE).

We’ve also seen Sandon Capital Investments (SNC) recently take over Mercantile Investment Company and Clime Capital (CAM) take over CBG Capital, building a bigger shareholder and funds under management base for each.

Pressure rises on underperformers

As global share markets continue their unabated march forward, adding upwards of 20% in 2019, pressure has heated up on LICs who have been unable to keep up, and have seen their funds move towards significant discounts to NAV, providing a double whammy to investors in those funds.

Launched only in late 2016, on its 3 year anniversary, Antipodes Global Investment Company (APL) trades close to a 20% discount to its underlying Net Asset Value. The wide discount was primarily due to its poor performance since listing, in FY 2019 returning 4.3%, compared to 18.9% for its benchmark global index. Activist investors are now demanding the fund wind up and return capital to investors .

Previous LIC darling Australian Leaders Fund (ALF) is also under pressure from investors. ALF plan a 20% buy back of shares at NAV in order to attempt to reduce the discount to NAV. Investors however are not happy, with many calling for a wind up of the fund, as it continues to trade at a 20% discount to NAV. Its been a phenomenal turnaround for ALF, who previously traded at close to a 20% premium to NAV and shows how the market can punish LICs who underperform.

ALF NAV 5 year Premium/Discount. Source: ETF Watch

L1 Capital, after breaking records with their L1 Long Short Fund (LSF) IPO have failed to live up to investor expectations to date and have traded at significant discounts to their NAV, peaking at about 22%. Some improved performance in the last few months have seen the discount close somewhat, but L1 continue to make headlines for the wrong reasons.

To battle its persistent discount to NAV, which has tracked at somewhere from 15-25% almost since inception, Monash Absolute Investment Company (MA1) has proposed to restructure as a Exchange Traded Managed Fund (ETMF) or ‘Active ETF’. By changing to an ETF, it will ensure trading at or close to NAV, albeit will lose the benefits of the LIC structure.

LIC discounts persist but the trend is changing

We’ve looked at LIC discounts a couple of times this year. First, pre election, when Labor’s proposed changes to franking credits saw LICs on masse have pressure put on their share price.

Later, we took another look and were surprised when the discounts to NAV actually grew. A few months later we’ve taken another look, with the results below:

Since discounts grew to their highest level in June 2019, there’s been some reversal of the trend, with discounts flatlining and reducing slightly in the few months since. The market however does still sit at a significant discount, particularly compared to this time a year ago.

We speculate, particularly in light of the names of the underperforming LICs above, that booming share markets have resulted in a large number of LIC managers struggling to provide outperformance, particularly the many with a ‘Value’ focus, in a period where momentum or ‘growth’ investing has outperformed. More on that below.

LIC Underperformance

It’s no secret that in rising share markets, professional fund managers tend to lose their edge. The last 12 months have seen the Australian share market return around 20%. As a result, many fund managers have simply failed to match the broader market return.

There’s also a number of LIC managers who employ short selling techniques, which can help to reduce volatility, but often have the effect of hampering returns in bull markets.

In the below chart we compare the performance of all Australian focused LICs we cover (excluding those that target just a particular sector, eg technology). To track performance we have measured the LIC preferred performance measure of using pre tax Net Asset Value changes from 31 October 2018 to 30 October 2019. We have also added dividends, but have excluded the impact of franking credits. With many LICs offering 100% fully franked dividends, this would slightly improve their performance compared to the benchmark we have used, the Vanguard Australian Shares Fund (VAS), which has reported franking of 80% over the period.

The chart shows of the 47 broad based Australian LICs, only 8 or 17% outperformed VAS over the period. Even perennial LIC favourites, and some of the oldest LICs on the ASX; AFI, ARG and MLT have been unable to outperform.

When it comes to global shares, our quasi benchmark for this exercise, Vanguard’s MSCI Index International Series ETF had a total performance of 16.7%. Of the 18 LICs that follow a broad global approach, only 3 or 17% outperformed our benchmark.

The markets in 2019 have certainly not been kind to active managers. However, a year does not maketh the manager. When markets were flat a few years ago, many of these LIC managers recorded their best performance.

Where to now for LICs?

We expect discounts to persist within LICs whilst the current bull market continues. However, we are now part of the longest bull market in history. When the tide turns, the manager skills will truly be tested and we may see a flight back to active from passive investing, removing the discounts. We’ll be sure to keep tabs on what happens in this space.

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