Finding value in Listed Investment Companies is becoming harder. After strong gains in the past 12 months, the LIC sector is trading at almost parity to its net tangible assets (NTA). The big discounts that plagued the sector in recent years have rapidly narrowed.
The sector traded at an average 2.87 per cent discount to its pre-tax NTA (weighted for market capitalisation) at the end of February, Australian Securities Exchange data shows. In January, the sector traded at a slight premium as the sharemarket rally boosted demand for LICs.
That is a remarkable turnaround for a sector that traded at a whopping 21 per cent average discount to its pre-tax NTA in February 2009 as the GFC flared. Persistent large discounts to NTA are a turn-off, because they suggest the market values the LIC at less than its assets are worth.
But big discounts, in the right LICs, can provide an attractive entry point for shareholders who are able to buy an LIC for, say, 80 cents a share, when its assets are worth $1 a share. LICs often trade at discount if the market is concerned about their investment performance, management, or ability to pay consistent dividends – of if weak market conditions reduce demand for their shares.
Investors who bought LICs last year have generally enjoyed solid gains. The sector traded at a 7.4 per cent discount to its pre-tax NTA in January 2012. The sharemarket rally in the second half of last year and the narrowing of discounts have given LIC investors a double boost.
The combined market capitalisation of LICs rose 28 per cent to $20 billion in the year to February 2013, and the average monthly value of those traded gained 20 per cent, according to ASX.
Greater interest in dividends and the sharemarket rally have helped LICs return to favour. Upcoming financial planning reforms will even the playing field between LICs and unit trusts by removing trailing commissions, and several LICs have raised more money this year than they original sought.
Placements by WAM Capital, Cadence Capital and Australian Leaders Fund have been heavily oversubscribed in the past 12 months.
That is a good story, but what matters most is how much of the improving outlook for LICs is already captured in the price. Two reports released in March have important insights of valuations within the LIC sector and the best opportunities for prospective investors.
Patersons’ excellent quantitative research on 30 LICs found most were trading at premiums to their historical price to NTA levels, except for Argo Investments, Milton Corporation, Diversified United Investments, Australian United Investments, and AMP Capital China.
WAM Capital, Clime Capital, Carlton Investments and Westoz are the most attractive LICs, based on analysis of price to NTA and long-term NTA growth rates, Patersons found. The report said: “Carlton Investments, and Westoz offer the best value … WAM and Westoz have the highest dividend yield at around 7.1 per cent and 7.6 per cent, fully franked, respectively.”
Aberdeen Leaders, Djerriwarrh, Mirrabook, Australian Leaders Fund and Magellan Flagship appeared most expensive, Patersons said.
Its research found the average dividend yield for LICs had fallen from 7.8 per cent (on a grossed-up basis) to 6.5 per cent over the past three months. The highest-yielding LICs, based on distribution trends, were Australian Leaders Fund, Westoz, Aberdeen Leaders, and WAM Capital. The largest LICs, in particular, are sought for their record of steady, reliable fully franked dividends.
Yield compression is not unique to the LIC sector. Popular income stocks, such as Telstra and the big four banks, now offer lower dividend yields after their sharp share price gains over 12 months. The LIC sector’s average 7.8 yield stacks up well against big-income stocks and comes with better diversification.
Independent Investment Research’s December quarterly LICs review, released last month, also found a sharp narrowing of value in the LIC sector. It said: “The sector garnered support in recent months, with a number of companies being re-rated by the market. The value on offer by some (LICs) has been recognised, which has resulted in a reduction of discounts … 85 per cent of the LICs covered in this review experienced a narrowing in the discount or expansion in the premium to pre-tax NTA over the December quarter.”
It found the top five performers for the December 2012 quarter, as calculated by pre-tax NTA plus dividends, were Australian Leaders funds, Whitefield, Argo, Diversified United and Milton Corporation.
Independent Investment Research has only one Highly Recommended rating (its top rating) on an LIC – Australian Leaders Funds. WAM Capital, Clime Capital and Whitefield were among several that received Recommended Plus ratings (the second highest).
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Tony Featherstone is a former managing editor of BRW and Shares magazines. All prices and analysis at Feb 14, 2013. The author implies no stock recommendations from the above commentary. Readers should do further research or talk to their financial adviser before acting on themes in this article.