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Listed Investment Company deals for 2019

It has been a big year for Listed Investment Companies (LICs) and Exchange Traded Funds, both finishing 2018 with about $40 billion on issue and vying for top spot on the ASX.

The number of LICs and listed trusts (LITs) continued to grow during 2018 and, based on ASX data, there were 114 LICs and LITs at the end of November 2018 with a combined market capitalisation of $41.3 billion. Based on our data, 10 new LICs and LITs listed in 2018 raising a total of $3.3 billion via initial public offers, or slightly less than the $3.7 billion raised in 2017 but significantly higher than 2015 and 2016.

The L1 Long Short Fund (ASX:LSF) was the largest raising at $1.3 billion representing 40% of the total funds raised with Hearts and Minds Investments (ASX:HM1) at $500 million and WAM Global (ASX:WGB) at $465 million coming in second and third. The $450 million Ophir High Conviction Fund (ASX:OPH) has converted from an unlisted unit trust to a LIT.

Investors becoming more discerning

We think more fund managers are likely to attempt to come to market in 2019 given the benefits that LICs and LITs provide fund managers in the form of a locked in, closed-ended pool of funds. However, with markets looking shaky, investors are likely to take a more cautious approach to new offers, particularly given the poor performance of LSF to date. In our view, fund managers will need to have a genuinely differentiated offer that meets a particular investor need in order to successfully raise new funds.

We have already seen two new offers not make it to listing over the past few weeks with Firetrail deciding to pull the Firetrail Absolute Return Limited offer after failing to attract a sufficiently wide spread of investors, despite reaching the minimum subscription. Cadence recently announced it would still continue with its Cadence Opportunities Fund offer despite not receiving the minimum subscription, but the company will not list on the ASX. In August, PM Capital Global Opportunities Fund (ASX:PGF) withdrew its converting security offer after not reaching the minimum subscription.

More opportunities in fixed income

The listing of MCP Master Income Trust in October 2017 breathed some new life into the fixed income sector with further growth in 2018 following the listing of three new listed invested trusts with a focus on fixed income. These three LITs raised a total of $820 million taking the market cap of the fixed income LIT sector to over $1.5 billion. There are now four fixed income LITs, each offering exposure to different classes of fixed income assets. MCP Master Income Trust (ASX:MXT) invests in a diversified portfolio of Australian corporate loans; Gryphon Capital Income Trust (ASX:GCI) invests in a portfolio of floating rate Asset Backed Securities, with a particular focus on Residential Mortgage Backed Securities; NB Global Corporate Income Trust invests in a well-diversified portfolio of global high yield (non-investment grade) corporate bonds; and Qualitas Real Estate Income Fund (ASX:QRI) invest in secured commercial real estate loans, predominantly in Australia, with up to 20% of the portfolio able to be invested in New Zealand.

Given current equity market volatility and the desire by SMSFs to hold securities that generate stable, high income with regular payments (all the fixed income LITs pay monthly distributions) we see scope for further fixed income style LITs paying regular distributions to come to market in 2019.

Fewer global offerings but investors remain underweight

There was only one pure international-focused LIC hit the markets in 2018, the Wilson Asset Management managed WAM Global (ASX:WGB). Most of the money came from loyal investors across Wilson Asset Management’s growing stable of LICs. Hearts and Minds Investments will also invest in global shares although its portfolio will comprise a blend of international and Australian shares given the mix of managers selecting stocks for the portfolio. Tribeca Global Natural Resources (ASX:TGF) which listed in October will also invest globally, but specifically in resources-related equities, credit instruments and outright commodities positions using a long-short strategy.

Despite increased interest in international equities in recent years, Australian investors remain underweight global shares and we believe there is still scope for more LICs/LITs to come to market in this space. However, current equity market volatility and geopolitcal tensions are likely to make this difficult in the short-term.

Initiating coverage of Templeton Global Growth

We have initiated coverage of Templeton Global Growth (ASX:TGG) a listed investment company that provides exposure to a long only portfolio of global shares. TGG has been listed since 1987 and has historically held a portfolio of more than 100 stocks, although this is in the process of being reduced to 40-60 securities. Stocks are selected based on Sir John Templeton’s value investment philosophy. TGG’s fees are low compared with peers with a 1.0% management fee and no performance fee, although the portfolio and share price have underperformed over the LIC’s history. TGG may suit investors looking for a value-driven diversified portfolio of global shares. It pays annual dividends which have been fully franked with the exception of FY2015 and FY2016 dividends.

Whilst TGG has paid dividends most years, historically there has been a degree of volatility in the dividend amounts. However, dividends have been steadily increasing since FY12. We initiated on TGG with a ‘Recommended’ rating. At the end of October 2018 the shares were trading at a 10.7% discount to pre-tax NTA.

Century Australia to merge with WAM Leaders

Century Australia (ASX:CYA) is set to merge with WAM Leaders (ASX:WLE) following the execution of a Scheme Implementation Agreement between the two listed investment companies. Under the agreement, WLE will acquire 100% of CYA via a share exchange based on the pre-tax net tangible assets of the respective entities. The scheme of arrangement is subject to approval by CYA shareholders with a meeting expected to be held in late January. Wilson Asset Management is the investment manager for both WLE and CYA. In April 2017 CYA shareholders voted to change the management from Perennial Value Management to Wilson Asset Management.

We think it makes sense for CYA, which has a market cap of just under $100m, to merge with the larger WLE. The combined market cap of the merged company will be close to $900m and CYA shareholders will benefit from the greater market liquidity of the larger LIC. Investors will also benefit from a reduction in the management expense ratio with the removal of duplicated expenses and remaining expenses spread over a larger asset base. Both LICs currently have similar investment strategies, investing in large cap Australian shares, so there will be no major changes to the management of the portfolio. Investors in CYA will continue to hold shares in an Australian large cap focused LIC managed by Wilson Asset Management.

We do not cover CYA and make no recommendations as to the merger proposal. However, we think basing the consideration for the merger on the pre-tax NTA of the respective entities is reasonable but note that CYA’s post tax NTA is higher than pre-tax NTA given a net deferred tax asset of 5.3 cents per CYA share. This means WLE shareholders will receive the benefit of these tax losses if they are realised in subsequent years.

Pinnacle terminates arrangements with Blue Sky

Pinnacle Investment Management and its subsidiary Alterium Investment Management have withdrawn the proposal for Alterium to be appointed the investment manager for Blue Sky Alternative Access Fund (ASX:BAF). Pinnacle said it considered Blue Sky Alternatives Investments (the BAF manager) willingness to enter into discussions with a competing party (Wilson Asset Management) was inconsistent with the co-operative basis on which Pinnacle agreed to proceed with the proposal. This leaves Wilson Asset Management as the only other party in discussions regarding the management of BAF.

In a letter to the BAF Board (which has been reconstituted following resignations, removal of two directors at the AGM and the appointment of two new directors) Wilson Asset Management reconfirmed its offer to take over the management of BAF and announced Adrian Siew, an experienced manager with private equity and alternatives experience, would oversee the management of the portfolio and Andy Smith, another experienced alternatives asset manager would be appointed to the investment committee. Under the proposal Geoff Wilson and Andrew Siew would be appointed to the BAF Board.

Shareholders in BAF have experienced a tumultuous time and despite a rally over the past few months, the shares are still trading at a sizable discount to pre-tax NTA. At present, the Wilson Asset Management proposal seems to be the only offer that might see a return to stability for BAF shareholders.

Regal planning to launch its first LIC in 2019

Hedge funds manager, Regal Funds Management, is planning to launch a new listed investment company in early 2019. There are suggestions the Manager may look to raise up to $500 million in a fund that combines a number of its existing strategies including its Long Short Australian Equity Fund. Regal joins Pengana Capital Group which is also lining up an offer for early 2019 with plans to raise up to $1,250 million for a Private Equity Trust. We will provide more details on these planned offers as they come closer to launch in the new year.

Spotlight on Whitefield

Founded in 1923, Whitefield (ASX:WHF) is one of the oldest listed investment companies on the ASX. It offers investors exposure to an actively managed, well-diversified portfolio of Australian industrial equities. The portfolio is managed by White Funds Management which has a small investment team with considerable equities experience. While the portfolio is well diversified, the top 10 stocks account for 48.8% of the portfolio, slightly higher than the benchmark index. There is a high weighting to the Financials sector with the four major banks being four of the top five investments.

WHF recently adjusted its objective from a longer-term outperformance objective to a medium-term objective. The company is now seeking to generate portfolio returns (before fees and taxes) that outperform the benchmark index (S&P/ASX 200 Industrials Accumulation Index) over rolling five-year periods. The change was made to account for the evolution of the investment strategy with the introduction of quantitative techniques allowing for a shorter-term outlook. After fees and taxes paid, and including dividends, WHF has delivered an average portfolio return of 8.7% p.a. over the past ten years, 0.7% below the S&P/ASX 200 Industrials index.

WHF seeks to provide investors with a cost-effective investment that delivers long-term capital growth and a reliable and growing dividend stream. The management fee at 0.25% p.a. and total management expense ratio under 0.40% are low for an externally managed LIC. Total full year dividends were held flat at 17 cents per share, fully franked, from FY2009 to FY2017 but have since been increasing. Following the partial conversion of its Convertible Resettable Preference Shares (CPRS) and rate reset on the remaining CPRS (to a lower rate) WHF expects to be able to support a higher level of dividends. A fully franked interim dividend of 9.75 cents per share was paid for 1H2019 and the company expects to pay a final dividend of at least 10 cps in June 2019. This equates to an attractive fully franked dividend yield of at least 4.7% based on the current share price.

WHF shares have historically traded at a discount to pre-tax NTA and at 31 October were trading at a discount of 5.5% compared to a three-year average discount of 8.0%. Given the improved dividends we think this is an attractive entry point for investors looking for exposure to a diversified, well-managed portfolio of Australian industrial equities. Investors should be aware that the discount may change on a daily basis in line with market movements. We also note that the CPRS conversion and recent share purchase plan issue may have impacted the pre-tax NTA.

 

Peter Rae is Supervisory Analyst at Independent Investment Research. This article is general information and does not consider the circumstances of any individual. The full December 2018 update from IIR is in our Education Centre, here.

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