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Managing LIC discounts and premiums

Over the course of the last 12 months we have seen discounts to NTA grow wider in most of our Listed Managed Investment (LMI or sometimes called Listed Investment Companies or LICs) coverage universe and, where they existed, premiums have narrowed or turned into discounts. Even LICs which have seen their shares trade at 20%+ premiums to NTA over the past few years, such as WAM Research Limited (ASX:WAX) and WAM Capital Limited (ASX:WAM), have seen their premiums to NTA contract to the smallest levels in many years.

Discounts can persist

This waxing and waning of premiums and discounts has been part and parcel of LIC investing for many years. This can provide opportunities for investors to buy at a discount but also make it more expensive for investors to access quality LICs trading at premiums. WAX and WAM have traded at persistent premiums for many years and those looking to buy into the shares at NTA, or even better a discount, were left in waiting.

Other names have traded at persistent discounts for many years with no end in sight despite, in some cases, solid underlying portfolio performance. The existence of these persistent discounts has led to corporate activity in the LMI sector with takeovers and mergers and more recently the windup of LIC’s such as 8IP Emerging Companies (ASX:8EC). We have also seen the restructure from a LIC to an active ETF vehicle in the case of Monash Absolute Investment Company (ASX:MA1).

Price management mechanisms

Despite the launch of on market and off market buybacks to try and control and narrow persistent discounts, we have not yet seen the introduction of explicit discount control mechanisms in the Australian market. These mechanisms are relatively commonplace in the UK Investment Trust (IT) space which is equivalent to the LIC space here in Australia.

A standard example would be that when a company’s shares trade at for example a greater than 10% discount to its NTA, this immediately triggers an on-market buyback by the company. Similarly, if the shares trade at a greater than 10% premium to its NTA the company would issue shares into the market at NTA. The logic behind this strategy is that as the discount control mechanism is clearly articulated it helps to keep the share price trading around its NTA as there is a clearly defined mechanism and course of action to be followed in case the share price moves well above or below the NTA. The band around which the share price can deviate from the NTA before the mechanisms are activated are set by the board and can be as tight or as loose as deemed fit given the underlying assets in the company.

While discount control mechanisms are not the panacea for persistent premiums and discounts, evidence from the UK market suggests they can help reduce large divergences from NTA and allow investors to trade in and out closer to NTA the majority of the time.

Many Australian LICs do have the ability to use buybacks as part of their capital management and a number of buybacks are currently in operation. Despite this, many continue to trade at large discounts with the buybacks often ineffective. Continued buyback of securities also leads to a reduction in fund size and may not be beneficial to LICs that are already subscale.

With the AGM season fast approaching for the majority of LICs in October and November, the issue of persistent discounts, along with potential strategies for addressing the discounts, is something that LIC shareholders can raise with boards at the AGM.

We expect further consolidation in the sector and other forms of corporate action designed to address both the size and persistence of discounts.

For further updates on LICs, including new issues, see the latest IIR Report for September 2019 here.

 

Peter Rae is Supervisory Analyst at Independent Investment Research. This article is general information and does not consider the circumstances of any individual.

 

  •   11 September 2019
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