Bumper dividends ahead for LIC investors

Many listed investment companies are flush with cash at the moment, especially equity-based vehicles that aggressively dialled back their dividends in the first half of calendar 2020. This makes sense, given that the dividend payouts of Australian-listed firms dropped by around 25% last year due to shutdowns, lockdowns and other measures to slow the pandemic. 

But the more rapid V-shaped economic recovery than many expected has elevated LIC cash levels. This left many with dividend payout ratios even higher than 100% for the first half of fiscal 2021, as highlighted in a recent report from Independent Investment Research.

Listed investment companies (LICs) and their “sister” structures, listed investment trusts (LITs) have drawn plenty of criticism in the last couple of years. Some of the most recent concerns centred around their legacy fee structures, which are called stamping fees in the LIC/LIT world. These were basically a hangover of commissions and other types of “conflicted remuneration” that were mostly cleaned up by the Future of Financial Advice (FoFA) reforms. Without going into more detail, suffice to say, Federal Treasury closed the loophole almost exactly a year ago.

The negative publicity saw many LIC unitholders pull their money out. This further reduced the liquidity of the closed-ended structures, where investors wanting to exit need to find a buyer.

But even before this, LICs and LITs had been challenged since at least the end of 2019, persistently trading below their net tangible assets (NTA) – which refers to the fair value of the portfolio of stocks, debt securities or alternative assets they hold.

Buybacks and other capital management initiatives have been used extensively by fund managers to try to address these discounts to NTA in recent years.

They include:

• A $54 million share placement by Qualitas Real Estate Income Fund (ASX: QRI)
• A $20 million capital raise by Bailador Technology Investments (ASX: BSI), via an institutional share placement
• A $23 million convertible note issuance by NAOS Emerging Opportunities Company (ASX: NCC)

Another, Monash Absolute Investment Company (ASX: MA1) is preparing to abandon the LIC structure entirely and transform into an exchange-traded managed fund – also known as an active ETF. In the works since mid-2020, shareholders are widely expected to approve the restructure later this month. This would see MA1 delisted, and a new ETMF called Monash Absolute Active Trust (ASX: MAAT) list on 10 June.

During a shareholder presentation last month, the LIC’s management outlined a removal of “the persistent discount to NTA” as key objectives of the shift, along with providing regular income to its investors.

Discounts are a feature, not a flaw

Coming back to the criticisms levelled at LICs and LITs regarding their propensity to trade at a discount to NTA, backers emphasise this is a feature of the structure rather than a flaw.

“You’ve got to embrace it and not run from it, you’ve got to put on your big boy pants and realise that sometimes the LIC will trade at a discount,” says Daryl Wilson, CEO and portfolio manager, Affluence Funds Management.

One of his flagship products is the Affluence LIC fund, an unlisted vehicle comprised of between 20 and 35 LICs which are mostly invested in either global or Australian stocks.

While Wilson doesn’t focus solely on dividend yields in selecting LICs for the fund, it’s an inevitable consideration. He estimates that probably more than half the market of LIC investors are in it primarily for their income potential.

Affluence looks for LICs that:

• Can grow their dividend yield
• Are trading at a decent discount, and
• Have an attractive strategy.

“That’s the holy trinity of LICs, as opposed to buying something that already has a decent yield but can’t necessarily grow too much from there,” Wilson says.
“If you want to get above-average performance, you’ve got to be a little bit ahead of the market. If you buy on yesterday’s yield, that’s data that everyone has, but if you’re thinking ahead then that can give you the potential for a double-whammy.”

Franking credits

These are key features for people who own LICs, who want the fully-franked dividend. And as Wilson highlights, this is another key distinction between ETFs, managed funds and LICs.

“Everyone loves their franking credits, but what they don’t understand is that if a LIC turns itself into a trust, it could pay a much higher cash dividend from day one,” he says.

“Because when a LIC floats, it has to make profits then it has to pay enough tax so it can attach a franking credit to the dividend, which can take two, three or even four or more years, especially if they have a pretty slow start performance-wise.

“We think there’s too much focus on franking credits…it’s inefficient because sometimes LICs build up these franking credits and bank them when they should be just paying them out and getting them out to investors.”

Though this characteristic of LICs – which unlike LITs, are able to regulate or “smooth” income payments by holding earnings on the balance sheet rather than paying out all profits in any given year – add to the attraction for many investors.

And this is where IIR’s latest quarterly report is interesting, in showing which equity LICs have the biggest cash reserves amassed.

Based on their current dividend yields, IIR estimates the following Australian share large-cap LICs have enough to fund dividends for more than eight years and just under seven years:

• Whitefield Limited (ASX: WHF)
• Flagship Investments (ASX: FSI)

And in the Australian small- to mid-cap universe, each of these has more than 15 years of dividend coverage:

• Thorney Opportunities (ASX: TOP)
• ECP Emerging Growth (ASX: ECP)
• Ozgrowth Limited (ASX: OZG)
• Carlton Investments Limited (ASX: CIN)

Among international share-focused LICs, the following have dividend coverage of nine years or more:

• Pengana International Equities (ASX: PIA)
• WCM Global Growth (ASX: WQG)
• Fat Prophets Global Contrarian (ASX: FPC)
• PM Capital Asian Opportunities (ASX: PAF)

Affluence’s Wilson also lists 10 (below) he believes have a high potential of boosting dividends in the next year or two:

And in terms of the Growth and Value debate, Wilson believes those LICs with an emphasis on more cyclical names will do particularly well over the next few years.

“Value LICs have really struggled, but we think they may well be the ones who do well,” Wilson says. “You’ve got to be a bit of a contrarian to do well out of backing active managers.”

A couple of his preferences among LICs with something of a value emphasis are:

• Sandon Capital Investments (ASX: SNC)
• Naos Emerging Opportunities Company (ASX: NCC).

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