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Don't let discounts and premiums blind you
This article appeared in the May 2012 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.
LICs, like other investments, are about performance.
By Boyd Peters, Contango
Shareholders and followers of Listed Investment Companies (LICs) may have noticed that fewer are publishing a discount or premium figure in their monthly Net Tangible Assets (NTA) statement. To determine this percentage, you simply divide the share price by NTA, two numbers typically among the first shown in the monthly statement.
A consensus has emerged among many LICs that focusing too much on premiums or discounts is a distraction from what investors should be looking at: How will my investment perform - the investment portfolio, the company and its share price?
All ASX companies are judged by the return shareholders receive through share price appreciation, dividends and any franking attached. Any remaining discount should be recognised as little more than a latent opportunity for investors that could be obtained in the future.
Two elements to LICs
LICs have two basic elements that generate return for shareholders: First, the underlying investment portfolio; second, the structure and promotional activities of the company itself.
Anyone not investing in an LIC because of perception surrounding a discount, misunderstands the investment.
For instance, let us assume you want to invest in the market because your view on global or domestic growth is positive. You undertake your asset-allocation decision and have chosen a manager you are confident has the ability to perform well through this period.
Assuming such, would it be logical to not buy shares in that LIC simply because its share price is trading at its NTA value - reasoning that because it has no discount it is not worth buying? Of course not. You would be ignoring the precise reason you wanted to invest in the company, which is to access future growth potential.
Likewise, once you have made your investment decisions, is it logical to not buy shares in an LIC because its share price was trading below its NTA value (at a discount)? Of course not. This is because when we invest, we are buying the future, not the past.
As a corollary to that, investors would be ill-advised to sell an LIC purely because its share price was trading above its NTA value.
Discount a secondary consideration
Needless to say it is understood that sometimes there are structural reasons why an LIC is at a premium or a discount, and these may remain. However, this should be a secondary consideration because typically that is already built into its share price. An investor's primary consideration remains what absolute return do you expect this investment to generate over your investment timeframe?
An important consideration to this is that dividend policies are usually affixed to the NTA and not the share price. The hypothetical example in Table 1 below shows what affect a discount has in improving dividend yield in an investment.
|NTA policy to pay dividends of||July 1 NTA was||Dividends will total||"Today's" share price||"Today's" NTA||Effective yield is|
|LIC A||6% of July 1 NTA||$0.90||5.4cps||$0.80||$1.00||6.75%|
|LIC B||8% of July 1 NTA||$1.40||11.2cps||$1.30||$1.50||8.61%|
Table 1: Source Contango MicroCap Limited
In addition, an LIC trading at a discount provides the same upside a geared portfolio can.
In the example above, buying $1 worth of assets for just $0.90 can be a bargain in itself, while it also means you have $1 worth of assets working in the market, at the acquisition cost of $0.90c. That 10 per cent discount is actively offering you a free investment kick of 11.11 per cent.
Table 2 is another reason investors should look beyond the discount when considering the performance and outlook of an LIC.
|Discount/ Premium to NTA||12-month NTA performance||12-month share price performance|
|LIC A||-10% Discount||+20%||+9%|
|LIC B||+10% Premium||-20%||-12%|
Table 2: Source Contango MicroCap Limited
It is apparent that neither premium nor discount provides any insight into what the actual shareholder return was over the given period (nor its dividends or franking). Clearly LIC A was the better investment through this period, notwithstanding that some may have thought LIC B, trading at a premium, was the better performer.
LIC A also demonstrates why the adage "but LICs trade at a discount" is an irrelevant consideration in making investment decisions.
Unfortunately, actual performance is too rarely considered in the discussion on discounts, although as investors become more educated and increasingly use exchange traded funds, LICs and direct equities, this will change.
Numbers can betray themselves
Education is important because to the casual observer the headline performance numbers can be understated through structural features. Namely, LICs can undertake capital events that affect reported NTA and share price returns, including issuing new shares and options to shareholders, paying dividends, offering dividend reinvestment plans at discounts to share price, and undertaking share consolidations or splits.
LIC NTA performance tables in a newspaper could show an LIC had total NTA growth of just 10 per cent over a five-year period. However, what these do not show is that shareholders within the company might have experienced a 50 per cent return on their investment through that same period.
Compounding this is that LICs pay tax at the company level; hence the NTA reported is an after tax-paid position. Consider this when viewing LIC performance tables and recognise that at any point in time one LIC may have just paid its tax instalments while another will shortly.
This explains why many LICs now provide portfolio performance with their market communications and why looking at comparative NTA or share price performance tables does not always reveal the overall picture. It also explains why LICs leave it to investors to "divide A by B" to determine the discount or premium, if they want to know.
About the author
Boyd Peters is National Distribution Manager at Contango MicroCap (ASX code: CTN). CTN is an investment company investing in a diversified portfolio of 60 to 100 Australian micro-cap companies listed on ASX with a market capitalisation generally between $10 million and $350 million. There are more than 1000 companies in this category. CTN produces a free Quarterly MicroCap Investment Commentary.
This article is an extract from a research paper on Australian LICs, which can be found on the Contango MicroCap website.
Listed Investment Companies provide a wealth of information on LICs. Use ASX Market Update information to review LIC premiums and discounts to NTA since 2004. View the monthly sector update to see overall LIC performance. Examine quarterly performance returns to gauge an LIC's investment performance against others.
The views, opinions or recommendations of the author in this article are solely those of the author and do not in any way reflect the views, opinions, recommendations, of ASX Limited ABN 98 008 624 691 and its related bodies corporate ("ASX"). ASX makes no representation or warranty with respect to the accuracy, completeness or currency of the content. The content is for educational purposes only and does not constitute financial advice. Independent advice should be obtained from an Australian financial services licensee before making investment decisions. To the extent permitted by law, ASX excludes all liability for any loss or damage arising in any way including by way of negligence.
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