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Heavy LIC discounting triggers corporate action

With the majority of listed investment companies trading below net asset backing, some LICs are under threat of takeover or wind-up, while others are working on ways to close the discount gap.

Analysts caution investors against buying LICs trading at a discount in the hope that corporate action will deliver a gain – especially if the company is “sub-optimal”.

Wealth Defender Equities has fallen to a takeover offer, HHY Fund faces a wind-up proposal, and Monash Absolute Investment Co has rejected a takeover offer, while proposing a ‘loyalty option’.

According to Independent Investment Research, at the end of the September quarter 80 per cent of the investment companies and investments trusts listed on the Australian Securities exchange were trading at a discount to their net tangible asset backing. Thirty-nine per cent were trading at discounts of more than 10 per cent.

Wilson Asset Management is in the thick of the action. At the end of last month, it moved to compulsory acquisition of Wealth Defender Equities Ltd, after launching a bid for the LIC earlier in September.

WAM’s pitch to Wealth Defender shareholders was that the fund had underperformed since inception and its shares were consistently trading at a discount to NTA.

WAM has also requested a unitholder meeting of HHY Fund, so that it can put a proposal to wind up the fund. WAM funds hold a combined 29.9 per cent of HHY, which has traded at a discount of 30 per cent below NTA this year.

Monash Absolute Investment Co has rejected a merger proposal from Sandon Capital Investments. Both are small and would have a combined NTA of less than $100 million if they did merge.

Monash shares are trading at a 16 per cent discount to NTA and a merger would allow Monash shareholders to exit at NTA.

Monash has its own proposal to increase its size and, hopefully, close the share price discount. It has announced a loyalty option issue. It issued a prospectus for an offer of one bonus option for each fully paid ordinary share and an offer of loyalty options at nil consideration upon exercise of the bonus options.

In September, Platinum Asset Management announced plans to allow its listed investment company to buy back shares “should the PTM share price trade at a significant discount to its underlying value.”

Independent Investment Research analyst Peter Rae says: “Given the preponderance of sub-$100 million market-cap LIC/LITs trading at large discounts, we believe this area of the market is open to further corporate action over the coming year

“We would not recommend buying LIC/LITs at a discount purely in the hope that corporate action may emerge and help eradicate the discount. Not all corporate actions are successful.

“We do not believe new share issues at a discount or option issues are in the best interest of existing shareholders and do not help in correcting discounts. While buybacks may provide an initial boost to share prices, they are unlikely to be effective in eradicating long-term discounts.

“We think improved performance, stable and growing dividends and better marketing and communications are all important catalysts for a narrowing of discounts.”

In June, Zenith Investment Partners published a report on LIC trading strategies, arguing that buying LICs that are trading at a discount to their net tangible asset backing can be a “valid investment strategy”.

Zenith looked at the data of 51 LICs (each with a market cap of $100 million or more), reviewing their 12-month total shareholder returns over the past five years.

It found that the sweet spot is LICs trading at discounts of 15 to 20 per cent below NTA. These LICs delivered an average 12-month total shareholder return of 18.2 per cent.

On the other hand, buying LICs with discounts of more than 20 per cent resulted in poorer results, and buying LICs trading at a premium also produced poor results. Zenith says there is “material danger” in buying LICs at strong premiums.

Investing in LICs involves a consideration of the underlying investment performance and the share price performance. LICs may be producing good portfolio returns but trade below NTA.

Zenith says that over longer periods factors such as portfolio performance and market sentiment begin to override any discount effect.

“While movements in share price relative to NTA may throw up advantageous opportunities to enter or exit positions in LICs, other drivers influence long-term outcomes,” it says.

“This is important, as it addresses a widespread view held by the market that LICs are unattractive versus unlisted managed fund.”

Zenith warns that LICs exhibiting negative features, such as sub-optimal scale, “egregious” fee terms, poor shareholder engagement practices and lack of transparency, will have difficulty overcoming share price discounts.

“Scale is important, as LICs with insufficient market capitalisation are more susceptible to trading negatively against their NTA,” it says.

“This tends to result in a negative feedback loop, where small LICs trade at a discount and then have difficulty in effectively raising capital to grow. This is often compounded by management using share buybacks as a way to support the share price.

“While this can have some positive impact, the effect is frequently transitory and also has the effect of reducing shares on issue, which may compound the original problem.”