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A checklist for buying LICs at a discount

Julia Stanistreet
28 February 2018
5

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.

discount, LICs, Listed Investment Companies, NAOS, net tangible assets, premium

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 01, 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
February 28, 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.

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