How can the worst feature of LICs also be the best?

From some analysis I did a while ago, I identified some other factors contributing to the discount / premium for LICs:
1. Fees - where fees are high, and / or locked in for an extended period for contractual or management control reasons, the NPV of those fee liabilities is high and that tends to lead to a discount.
2. Options issued - an options overhang can put a ceiling on the share price.
3. For long-established LICs like ARGO and AFIC which buy and hold for decades with low turnover, there are potential CGT liabilities, but unless the shares are sold they don't pay the CGT, so the income and franking is paid on the gross pre-tax assets rather than the net after-tax NTA and the price reflects the value of the additional, steadily rising franked income plus the after-tax NTA. Funds which turn over regularly and ETFs don't get that tax treatment.

Just a point wbich no-one seems to have made and may or may not be relevant and on which I would appreciate comment. LIC managers have cash holdings which vary according to market conditions to enable them to counter fluctuations. Does this make them less volatile than ETFs?
One thing that annoys me is performance fees. When the markets are on the rise the managers take credit and charge fees, but but do not do the opposite as their share prices follow a falling market.

Graham hi
Your write several times ...the investors with issuers such as Antipodes, Monash and Ellerston don't agree because they were complaining so much about the discounts that the managers went to a lot of trouble to convert to another structure. Are you able to indicate a commentary on these conversions and the outcomes---and why wld other LIC managers not do the same?

Thanks to FirstLinks for amplifying some of the discussion Geoff Wilson and I had at the Morningstar conference and to all of the FirstLinks readers for their the energetic engagement with this piece. It's a good sign that investors out there still care about the LIC sector, a sector that provides some unique benefits (income, private assets etc), including my favorite "click to buy" convenience of investing in a fund via the stock exchange.

Peter “ Would you worry that the price I bought or sold is above or below Morningstar’s assessment of fair value?” - an analyst’s fair value is subjective and there is not an agreed fair value for a company. A LIC’s NTA (most LICs invest in listed securities) is mark to market. Why should a BHP shares housed in LIC be 20% cheaper than a BHP share in an ETF or a managed fund? If you participated in a LIC’s IPO you have paid the market price for BHP, not at 20% discount. This discount only happens when you try to exit. Peter, you might be thinking that LICs can smooth the dividend payments so the dividends you receive don’t fluctuate as ETFs’? This dividend smoothing feature makes it easier for tax and/or expenditure planning.

If WAR stays at a discount perhaps Geoff could raise more money to buy the discounted LICs that buy the discounted LICs. The WARTT, WAR times two?

Adrian, thanks for making me laugh on a Sunday morning. That's very funny.

My pleasure George, of course from the investor perspective it would be WAR Three Times (the management fees being paid) but it's still a WARTT :)

There's another side to this problem not discussed here. I have been on the board of a LIC trading at a discount, and it totally dominated board discussions. Buybacks, marketing, mergers. It felt it was all we talked about, instead of planning for the growth of the business.

I am confused by this article. What matters is whether I sell higher or lower than what I buy for, not NTA.
Wison's LIC (WAR) was trading ($1.17) at a discount (7%) to its NTA ($1.26) while LIC (WMI) was trading ($2.02) at a premium (23%) to its NTA ($1.64). So what? I bought in for its prospects.
Graham says: "If something happens at the manager, such as a change in personnel or an unwelcome portfolio change, some LICs are so poorly supported that investors are forced to hang on or liquidate at a 20%+ discount."
Yes, agreed, but the same thing can happen to any share or ETF. Buy at $10 and if the price drops to and stays at $8 you are on a 20% loss, irrespective of NTA or IPO price.
When I buy and sell shares, ETFs and LICs I don't even look at their NTAs. What matters is my selling price less purchase price, because that determines my gain or loss.
I seek capital apprciation and dividend yield growth over time, which is based on purchase price, not NTA.
I use EPS not NTA for calculating dividend coverage and P/E ratios.
What am I missing? I doubt there is a positive correlation between share price and NTA. So why is NTA important to me as the share buyer, holder and seller?
[I prefer to be educated rather than chastised for asking these questions!]

AlanB, I fully agree with you. As I have said previously in this article, it is the spendable profits, the difference between buying and selling price that matter. Dividends with or without franking credits (different from distributions) matter to many investors. A premium to NTA is a common sign that the LIC pays consistent, usually franked, dividends which appeals to and therefore attracts self-funded retirees. Conversely, a discount to NTA shows a reduced appeal to investors and the reason may be the investment focus, the dividend or lack thereof, the management performance. Look for the reason before investing or rejecting an LIC. As far as I can reason, the whole argument underpinning this and many previous articles was the immediate discount applied by the market once an IPO was completed. This was based on the fact that there was no market history to work from except the history of the manager. Furthermore, the fund needed a couple of years to establish a portfolio to the extent it could pay dividends, initially small, later becoming stable and consistent. Add in the associated poor marketing of the IPO and many new investors sold out because they wanted their returns earlier than these new LICs could provide. Rationalisation has seen a number of LICs taken over, change structure or go private. Now we are seeing LIC's image suffering because they are honest enough and are legally required to inform the market of the discount/premium to NTA to allow investors to see more clearly how well investors support each LIC and raise questions on why they should in invest in the LIC. I have followed LICs since 2002, bought in and out of the best and the worst, participated in IPOs and swear to be careful before buying into an IPO. I now prefer Hedge Fund type LICs associated with much larger FUM unlisted funds because of the range of management practices they can use to protect my downside or make more upside for me.

Hi AlanB, ETFs trade at their NTA, plus or minus a small spread. So when you say, "the same thing can happen to any share or ETF. Buy at $10 and if the price drops to and stays at $8 you are on a 20% loss, irrespective of NTA" ... that is simply not true, regardless of what you think about my overall argument. With an ETF, it is not "irrespective of NTA", it is because of the NTA. The ETF loses 20% because the NTA falls 20%.

Let's say you support a LIC at issue after hearing the pitch from the fund manager. Your adviser also puts her reputation on the line by backing the manager for many of her clients. You had unlimited investment possibilities but you bought into this story of the manager's investment ability and willingness to support the LIC structure. Over the next year, the market rises 10% and the NTA of the fund rises 10%, but the price of the shares falls 10%. For whatever reason, you need to sell. If you had chosen a cheap index fund or a structure where exit price=NTA (eg ETF, unlisted fund), you'd be up 10%. Instead, you're down 10%. Yes, as you say "What matters is my selling price less purchase price" and you just lost 10% because the manager is unable to stop the discount. That's why Ellerston, Monash and Antipodes changed after investor disquiet. And you say ... "I doubt there is a positive correlation between share price and NTA." Really! Again, regardless of what you think about my argument, surely you recognise there is a positive relationship between the value of the underlying assets and share price, even for LICs. There are 100 LICs on issue. Do you not think that if the market rose 100%, the vast majority (all?) would rise in price, regardless of variations in the discount. Or if the market fell 50%, do you think LIC prices would not fall?

Graham and Graham - thank you for your responses, although one in agreement, one not. I readily concede there are many (most?) on this forum who know far more than me and can see wheels turning within wheels that are beyond my comprehension. I still believe that share prices are primarily determined by market sentiment, often irrational, rather than NTA backing. Yes, share prices can follow NTA movements and if NTA declines to the extent it alarms the market then prices will decline. Discounts and premiums. You indicate ETF prices rise and fall because of the NTA, by the same %. You also say that if the market and NTA rise by 10%, the LIC price could fall by 10%. I interpret that as the NTA having a different impact on shares, ETFs and LICs. I recognise share prices deviate wildly from underlying assets. BHP's price is $47.96 and its NTA $13.32. Yet we still buy BHP. Yes, on your final point I can quite see that a rising tide lifts all boats. Reading through today's AFR I see no focus on NTAs, either in commentary, half-yearly company reports or share tables, suggesting that for most investors NTA is not a critical factor in decision making. Thank you again for your response and I leave you with another quote from 'A Tale of two Cities' “A day wasted on others is not wasted on one’s self.”

AlanB, Don't undersell yourself. YOU are right in your rationale here. By the way, in LICs, shareprices and NTA values move freely and independently whereas in ETFs, the shareprice is tied to the NTA value by a marketmaker with allowance for a margin of difference for their profit, not by free market forces of supply and demand that apply to LICs. That in itself opens a whole new range of issues I have no wish to discuss here.

Graham - thanks. It's reassuring to know I haven't got it entirely wrong.

Very well put . l myself similarly view Lics as just another tradable stock .

As an aside , l once emailed the Wilson group about the possibility of forming a new Lic to contain just the other seven Wilson Lics themselves .

l did not receive a reply .


Take care . Ramon .

Some LIC's fully deserve large discounts, and few deserve meaningful premiums. I would use Geoff Wilsons list of LIC's he is buying as a guide to what is "safe", to buy or invest in. The LIC's that have a discount exceeding, say 15% that have not been included, may well be unattractive to other investors too. Reasons may be that the incumbent management, can not be dislodged and use shareholders funds for what amounts to gambling, may just like getting board fees, or are just poor investors. With managers who have long term management contracts with various fees and incentives, investors have to do their homework, as to whether the incumbents add value to your investment, or is it best to look elsewhere. The discount to nta is in my view the markets way of grading the overall effectiveness of an LIC management team, which of course includes perceptions, that do not affect nta, such as publicity, public relations, and attitudes.

An LICs like BKI has performed very well over the 18 or more years it has existed as a spin off from Brickworks.

Steadily rising fully franked dividends, rising share price. TSR is very satisfactory, MER .17. Transparent ASX listed trading.

Sure it usually trades at a discount to NTA, but what's there not to like?

I like BKI. Trouble is I bought them at a discount and they seem to be destined to trade at a discount forever. I presume it is the extra carbon in the portfolio. They are a good size and as you point out the MER is attractive. Maybe they will be rerated when/if they sell sell out of NHC but I don't mind that investment. Most of the investments are stock standard stuff for LICs.

From AFR today, another one bites the dust . "AEG has been trading at a steep discount, and received two strikes against its remuneration report, leaving it with little choice but to return capital to shareholders, convert to a different investment structure, or merge with another LIC."

The mobile phone analogy is inaccurate.
You can always turn off the phone. Can't turn off discounts

Can't turn off your phone if want to use it for the other hundred things a phone does these days.

I can and I do

Well when I am bush walking in Kosi NP I always turn off my mobile as it rarely has reception. Thus it lasts for 6+ days at least. When I am home I turn it off when I got to bed and on when I get up. We all deserve in an uninterrupted sleep at night. O mobile is a tool! its not life!

If a LIC trades at a discount above 10% for a period of over 2 years then LIC management should be obliged to sell the assets at NTA and reimburse the shareholders at NTA. Unlikely I know as LIC management gets paid on NTA and the gravy train would cease.

Hi Kris, yes, of course. But my main point is that someone supported this manager at IPO stage (placing trust and faith in the manager or the adviser or the broker or, indeed, the LIC structure) and their asset is worth 20% less than the underlying securities. So buying at a 20% discount and selling at a 20% discount is fine, but someone took the 20% hit. How can that be a a good investor experience?

If we get dividends on $1(NTA) but only have to pay 90 cents surely that is a good thing for an investor.

Hi Janine, fine if you never want to sell. Let me quote Chris Meyer again: "We tried everything, we did the ASX’s biggest buyback, we put in a big effort on marketing and communication. But at the end of the day, we took the decision that we needed to do something in the best interest of shareholders."

But the discount can persist or get worse when you want to sell

Hi again, Peter, taking that to its logical conclusion, that a profit is a profit and that's all that matters, a LIC could rise from $1 to $1.10 while the unlisted managed fund from the same manager holding the same assets (as many LIC issuers run a listed and unlisted version) rises from $1 to $2 and that would be fine. A profit is a profit. Apparently, the investors with issuers such as Antipodes, Monash and Ellerston don't agree because they were complaining so much about the discounts that the managers went to a lot of trouble to convert to another structure. All this being said, I personally hold several LICs and the structure works well in many cases.

Is the above chart based on ‘Median Valuation’ ? If so it assigns the same value for a large market cap LIC as it does a small market cap LIC? The ‘median valuation’ is not an accurate reflection of the average dollar invested in LICs. It skews the discount toward the many small and subscale vehicles which are irrelevant to most investors. This is often a tactic to show a larger discount. Using a Median Valuation, AFI which has a $10Bn+ market cap and NAC with a $52m market cap, are assigned the same weight, which is crazy. The average dollar invested in LICs calculation will tell investors whether the sum of all dollars invested is trading at a premium or a discount, and the LIC market is currently trading at par, or to be precise a 0.4% discount.

Thanks, Chris, fair comment, but my article is mainly about the large number of LICs that trade at persistent discounts which is a poor investment experience. The chart shows the high number below the NTA line. Of course, among 100 or so LICs, some trade well and have strong support (including the traditional LICs such as AFI) and indeed I personally hold some of them. But there's a reason managers with LICs at persistent discounts convert to other structures after years of trying to address the problem in other ways.

Chris, I think it's the other way around. The discount problem is not with the big funds like AFI, ARG, WLE and DJW. They are well supported and have a good history in LIC land. Including them in the 'average' calculation disguises the dozens of duds. The most important part of the chart is not the white dot but the range, showing all those LICs at big discounts. Most managers are happy to go along keeping their locked-in money.

If I buy an established LIC at a good price and sell it later at a profit why should I worry about its NTA?

Hi Peter, So if the market rises 20% and you sell your LIC 'at a profit' of 10% more than you paid for it, as the discount has increased 10%, is that worth worrying about? That's why NTA matters.

Graham, Thanks for your reply. However, I can’t follow your logic. A profit is a profit and a loss is a loss. If I buy Coles, for example, at $15 and sell for $16 I have made a profit of $1. Would you worry that the price I bought or sold is above or below Morningstar’s assessment of fair value? I agree with Graham Wright’s comment that there is an undue emphasis on the NTA discount aspect of LICs.

Graham, I cannot see why discounted NTA matters when selling. Its the profit in my pocket I spend, not the change in NTA. NTA is an investor sentiment indicator, affecting my "why to buy/sell" decision and does not contribute to my profit/loss.
When the shareprice is at a premium compared to NTA, it most commonly means that for whatever reason, there is a market demand so great for those LIC shares, the investors are willing to pay a premium to own them. Who is complaining about paying a premium to buy those shares if they feel they would benefit from owning them?
When the shareprice is at a discount compared to NTA, it most commonly means that for whatever reason, there is a market demand so low for those LIC shares, the investors are willing to pay a discount to buy them. It behoves the seller and buyer to understand why that lack of demand exists and determine if a buy or sell proposition exists..
Then there are the LIC management teams and staff who are regular buyers of discounted shares in their own LIC (as visible in ASX announcements as required) to the extent that some have become substantial shareholders. Surely that demonstrates a faith that investors could investigate and maybe support and thus demand could reduce the discount or even bring it to a premium.

Hi Graham,
If I buy an LIC trading at a 20% discount to NTA with Share price =80c, NTA=$1.
Assume over 12 months the underlying assets grow by 10%.
NTA is now $1.10. Assuming the LIC is still trading at a 20% discount the shares are now trading at 88c.
If I want to exit my investment I still make exactly the same 10% return as the underlying asset.

Kris, you can't assume that a particular discount or premium will exist consistently over any time scale. Shareprices and NTA vary independently, daily, and the premium/discount exists only when you relate a particular shareprice to the NTA that can be calculated at that same time. Analysts like Bell Potter put out tables monthly showing historical NTA variations and the subsequent premiums and discounts that occurred in the same period. These values are not constants, varying daily, weekly or monthly as calculated.

Hi Graham W. My assumptions were just to demonstrate that the existence of a discount to NTA doesn't affect the profit in any way (provided the discount is the same when you buy and sell). Of course discounts can vary every day, but aswell as increase, discounts to NTA can also decrease, which can make your profit even better than if you were investing in an ETF at NTA.

Graham H. I do take your point about the IPO-level investors for the majority of LIC's.

There seems to be a tremendous bias against LICs in this Newsletter with all the past and now present article about the discount/premium aspects of LICs. The topic is regularly raised with the same tired old arguments as if it is a good topic to write on when there is nothing else controversial to write on.
Simply, LIC discounts and premiums reflect investor sentiment for whatever reasons prevail on a daily basis. But so do the market prices on all other marketed products. So why pick on this one? At least LICs are honest in displaying the NTA/Shareprice differentiations. It is seldom visible so easily elsewhere in the market. And the differentiation occurs as a result of market forces whereas for most other funds, the differentiation is managed and therefore hides or distorts the truth of what is happening in the market of the product. When investors in LICs vote with their feet, its visible to the world. Is investor voting so visibly separated from fundamental and technical factors in all other product markets?

Perhaps you haven't suffered the experience of IPO investors or those who bought close to NTA only to then watch it plunge into 10 - 20% discounts for years ?

"Anyone for a discount on a discount?" With WAR you're also paying fees on fees! 

yes exactly!

Do investors realise how small some LICs are? Many are sub $50m but have all the fixed costs of boards, compliance, legals, ASX listing.

Some LIc,s have an advantage over ETF's. That is, a Lic can offer fully franked dividend which ETF's don't. This has tax implications for the income seeking investor. As for me, I have long term investments in ARGO and AFIC and benefit from a consistent tax free dividend/income. I think investors need to think about their investment objectives.

Hi Pete, you're off the track here. Australian equity ETFs pay franked dividends. In fact, some of them are specifically designed to access franking for income investors. What do you think happens to the franking credits if they are not paid to investors? Nothing against ARGO and AFIC, stick with them.