Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 242

A checklist for buying LICs at a discount

As a rational value investor, it makes sense to buy an asset at a price less than the tangible value of the asset with an expectation that over time, the value will be realised. Listed Investment Companies (LICs) trading at discounts to their net tangible assets per share (NTA) may present a value opportunity but if these discounts persist over time, then this value may never be released. Some LICs remain at a discount to their NTA for years.

Here is a very simple illustration of a discount and premium to NTA.

You have $10,000 to invest in the stock market and you’ve decided to use a LIC to gain exposure to a particular equities strategy.

LIC opportunity 1 with discount to NTA

LIC 1 offers a basket of listed stocks, and 10,000 shares with an underlying market value of $10,000 and NTA of $1 per share are available for a 10% discount of 90 cents. You pay $9,000 for $10,000 worth of underlying stocks.

LIC opportunity 2 with premium to NTA

LIC 2 offers a basket of listed stocks, and 10,000 shares with an underlying market value of $10,000 and NTA of $1 per share are available for a 10% premium of $1.10. You pay $11,000 for $10,000 worth of underlying stocks.

What causes this disparity?

These differences occur despite the NTA being readily identifiable from the issuer’s website or ASX announcements.

For example, a LIC premium to NTA can exist when there is a lot of demand for the LIC for various reasons, or if the company is issuing more shares at a price greater than the NTA. However, if there is little demand for a LIC, selling activity can place downward pressure on the share price causing it to trade at a discount. If a company issues more shares at a share price lower than the NTA, this can further exaggerate the discount. The management and boards of LIC need to closely watch the relationship between NTA and the price of new shares.

On first look, it seems the rational investor could take advantage of the discount opportunity, but the following is a list of the key items investors should consider to gauge whether a LIC trading at a discount could move towards trading at NTA or even a premium.

It’s not an exact science but in our view, a LIC trading at a discount exhibiting many of the positive attributes mentioned above could present an opportunity to unlock value via the narrowing of the discount over time.

 

Julia Stanistreet is a Business Development Manager at NAOS Asset Management. This content has been prepared without taking account of the objectives, financial situation or needs of any individual. It does not constitute formal advice. 

5 Comments
Andrew
March 12, 2019

If there is a substantial discount, why doesn't the management buy back the company shares by selling off some NTA, enhancing the NTA per share for the remaining shareholders?

Graham Hand
March 12, 2019

Hi Andrew, they often do. LICs regularly run capital management programmes where they buyback their own shares at a discount. Of course, some are reluctant to do it because a smaller fund means less fees.

Graeme
March 02, 2018

I would generally agree with Ashley’s assertions of LIC’s trading at discounts at market tops and bottoms, though the former is not as reliable. I disagree with his view that it is necessarily a problem. Obviously if one panic sells any stock at the bottom, you are going to do poorly. However buying LICs in 2009 meant you were going to do very well. WIL (now WAX) and PET around 50c, CDM and MFF around 60c were a major factor in my early retirement. And if you get the buying right there is often no need to sell, so discounts at tops also cease to be a problem.

Mike
March 01, 2018

I've been invested in LIC's since the start of the 1980's and its been a good way to build wealth through that period. The trick is to get a good board who are the managers.. The trouble now is that some funds are so big they need to broaden their focus to find growth because their Australian Assets are not growing. The other issue is that once your portfolio is big enough you can replicate what the LIC is doing in any event. But for people starting out I think this is great place to get a bit of diversity and safety in not having all eggs in a single basket. I think some of the board members of the LIC are charging too much for their services particularly where the portfolio does not change all that much from year to year. However, the LIC will generally follow the general market but as with all markets there are times where this becomes over or under valued and that is the point of the article.

Ashley
March 01, 2018

Problem is most LICs tend to trade at discounts near the peak of boom markets (late dot com boom, late credit/China boom, etc) when more retail investors pluck up the courage and shift from LICs to trying to play the market themselves. The market then crashes. So discounted LICs at or near the top doesn’t help. Then in the crashes (tech wreck, GFC) LIC discounts get even wider, so if investors panic sell at the bottom, they get clobbered worse when they finally capitulate and give up at the bottom – eg early 2009 when you couldn’t even give LICs away.

 

Leave a Comment:

     

RELATED ARTICLES

Managing LIC discounts and premiums

International LICs can have a fully franked future

The merits of investing in LICs at a discount

banner

Most viewed in recent weeks

The risk-return tradeoff: What’s the right asset mix for a 5% return?

Conservative investors are forced to choose between protecting capital and accepting lower income while drawing down capital to maintain living standards or taking additional risk. How can you strike a balance?

How long will my retirement savings last?

Many self-funded retirees will outlive their savings as most men and women now aged 65 will survive at least another 20 years. Compare your spending with how much you earn to see how long your money will last.

Buffett's favourite indicator versus all-in equities

Peter Thornhill shows how his personal portfolio has thrived under an 'all-in equities' strategy, but Warren Buffett's favourite valuation indicator says stock markets are priced at their most extreme ever.

In fact, most people have no super when they die

Contrary to the popular belief supported by the 'fact base' of the Retirement Income Review, four in every five Australians aged 60 and over have no super in the period up to four years before their death.

Five timeless lessons from a life in investing

40 years of investing is distilled into five crucial lessons. An overall theme is to embrace uncertainty to make an impact on how much you earn, how much you spend, how much you save and how much risk you take.

Welcome to Firstlinks Edition 403

Most Australians hold their superannuation in a balanced fund, often 60% growth/40% defensive or 70%/30%. Lifecycle funds are also popular, where the amount in defensive assets increases with age. Employees who are not engaged with their super (and that's most people when they start full-time work) simply tick a box for the default fund selected on their behalf by their employer. Are these funds still appropriate?

  • 15 April 2021

Latest Updates

Property

Whoyagonnacall? 10 unspoken risks buying off-the-plan

All new apartment buildings have defects, and inexperienced owners assume someone else will fix them. But developers and builders will not volunteer to spend time and money unless someone fights them. Part 1

Superannuation

Super changes, the Budget and 2021 versus 2022

Josh Frydenberg's third budget contained changes to superannuation and other rules but their effective date is expected to be 1 July 2022. Take care not to confuse them with changes due on 1 July 2021.

Economy

Why don't higher prices translate into inflation? Blame hedonism

Why are prices rising but not the CPI? When we measure inflation, we aren’t measuring raw price changes, we’re measuring the pleasure-adjusted or utility-adjusted price changes, and we use it incorrectly.

Economy

Should investors brace for uncomfortably high inflation?

The global recession came quickly and deeply but it has given way to a strong rebound. What are the lessons for investors, how should a portfolio change and what role will inflation play?

Risk management

Revealed: Madoff so close to embezzling Australian investors

We are publishing this anonymously knowing it comes from an impeccable source. Bernie Madoff’s fund was almost distributed to retail Australian investors a year before the largest-ever hedge fund fraud was exposed.

Exchange traded products

How long can your LICs continue to pay dividends?

Some LICs have recently paid out more in dividends than their net profit as they have the ability to tap their retained profits and reserves. Others reduced dividends to ease the burden on cashflow and balance sheets.

SMSF strategies

How SMSF contribution reserving can use the higher caps

With the increase in the concessional cap to $27,500 on 1 July 2021, a contribution reserving strategy could allow a member to make and claim deductions for personal contributions of up to $52,500 this year.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.