The Melbourne Cup Guide to LICs

Here we go again, the seventh running of the Affluence LIC Melbourne Cup!!! There is almost $50 billion of gamblers (investors) money at stake in the Listed Investment Company sector, so it’s certainly a lot bigger.

To win the real Melbourne Cup requires a horse that is well trained, has a great jockey, and hasn’t been hit too hard with a weight handicap from the stewards. To win the Affluence LIC Cup, a LIC requires many of the same attributes. They require a great trainer (the investment manager), an opportunistic jockey (the individual portfolio manager responsible for investment decisions), and a favourable handicap (starting discount or premium to NTA). Get all that right, and a good result for the owners (shareholders) will surely not be too far away.

We would hasten to mention that training conditions in the last month have been more difficult than usual. A 5%-10% equity market correction is similar to a month’s solid rain on the track for the real Melbourne Cup. Conditions are a little soggy. But in the last couple of days, the sun has come out and the track is drying quickly. This has made the field a little trickier to pick this year.

It’s also worth mentioning that the number of LICs available for the race has been shrinking over the last few years. In the last two years, 13 LICs have left the field through a merger with another LIC, converting to an exchange traded managed funds or merged with unlisted funds. Even in this year’s race four runners have announced their retirement, and this will be the last run for Partners Group Global Income (ASX: PGG), NB Global Corporate Income (ASX: NBI), Magellan Global Fund (ASX: MGF) and Forager Australian Shares (ASX: FOR).

We don’t believe that these four will be the last to leave the race, as the stewards harsh handicaps have disillusioned some punters. But taking a glass half full view, even if the sector was heading for the sidelines, the value on offer during this period is exceptional if investors can capture the discounts on offer. The new popular structure for LICs heading out to pasture is to charge a reducing “exit fee” over the first 12 months after delisting. This exit fee is not paid to the manager but is retained by the fund for the benefit of the remaining investors. A cynic may take the view that this structure is designed to stop hedge funds and other arb investors from flooding into the LIC before delisting and then exiting at the first opportunity and taking the managers FUM with them. Patient investors can potentially benefit from these exits, knowing they will get the portfolio return of the fund plus the discount over the exit period.

Finally, one of the key differences this year is the contrast in performance coming into the race between the bigger thoroughbreds and the smaller horses. Large caps have outperformed by approximately 20% over the past 18 months, and we believe that this head start in terms of a better starting valuation for the small caps will give them a distinct advantage over such a long race.

Who would make the cut?

We have analysed the field of over 100 LICs, and here, in no particular order, are our 24 starters for the “Race that Stops the Investing Nation”.

WAM Microcap (ASX: WMI)

• Starting Handicap: 15% premium
• Form Guide: Great long-term performance has resulted in a big handicap from the stewards. Starting at a 15% premium makes it harder, but this jockey and trainer know a thing or two about long races and we expect this one to come through the race better than most. 

Forager Australian Share Fund (ASX: FOR)

• Starting Handicap: 10% discount 
• Form guide: This is one of a number of horses where the trainer and jockey have made the difficult decision that this will be the last time they line up for the race. We are impressed with the respect the jockey has shown the other owners. The stewards have been assigned a 10% discount, however, there is a very high chance that this will be reduced to close to zero in the next 12-18 months. This will be a very strong runner for its last race.

WAM Strategic (ASX: WAR)

• Starting Handicap: 10% discount
• Form guide: The training regime for this runner consists of buying up ownership stakes in last year's laggards and trying to get them back into race shape. Performance has been a little hampered so far by a large position stake in stablemate WGB, and it appears they will be holding this position for quite a while yet. But it’s at a reasonable starting handicap, and if conditions go their way, then a superior performance is within reach.

NGE Capital (ASX: NGE)

• Starting Handicap: 20% discount
• Form guide: One of the field's best performers over the past 3 years, yet the handicap still appears well overdone at a 20% discount. NGE has a real advantage due to its small size and unconventional training strategy. Likes to take chances and could be a real challenger. Distantly related to the bigger and highly backed LSF.

NB Global Corporate Income (ASX: NBI)

• Starting Handicap: 10% discount
• Form guide: This is another trainer that has announced this will be its last run in the big show. This international horse ran well on a flat track but started to struggle when it got a little rough. Like FOR, there is a very high chance the discount is going to zero over the next 12-18 months, giving this horse a strong start.

Salter Brothers Emerging Companies (ASX: SB2)

• Starting Handicap: 35% discount
• Form guide: Relative newcomer to the race and has faced difficult conditions since entering. The trainer focuses their efforts towards the smaller end of the market which has been a treacherous space recently. However, the value on offer plus the very generous handicap means this is definitely one to watch.

Magellan Global Fund (ASX: MGF)

• Starting Handicap: 10% discount
• Form guide: One of the runners who has announced their retirement and is likely running for the last time. There is some controversy behind the scenes, with a protest lodged with the stewards by one of the part owners. The first win has gone to the trainer, but it is likely there are more protests to come. Has been a little out of form lately, however with a good prospect of gaining a 10% discount over the short to medium term this horse is likely to be competitive.

CD Private Equity Series (ASX: CD1, ASX: CD2, ASX: CD3)

• Starting Handicap: 25-30% discount
• Form guide: These three stable mates have been surprisingly strong performers over the past few years, and the whole while the stewards continue to let them get away with big discounts. There have been some administrative changes behind the scenes with the trainer, but the same successful jockey is in place. We keep expecting these three to fatigue at some point, but so far there are no signs of a drop-off. We’ve won good money backing these over the past few years.

WAM Leaders (ASX: WLE)

• Starting Handicap: 5% premium
• Form guide: One of the top performers in the last year and continues to run well and outperform most of its stablemates. We expect another reasonably strong race this year, though the word is that a related horse is making a debut in the unlisted fund stakes in the near future, which may prove a short-term distraction.

QV Equities Limited (ASX: QVE)

• Starting Handicap: 10% discount
• Form guide: The jockey who rode this one for many years has recently retired and the stewards have been a bit kinder than usual with the handicap. Likely to finish mid-pack or better, but a win would be a surprise.

Australian Foundation Investment Co (ASX: AFI)

• Starting Handicap: Around NTA
• Form guide: This huge mare and local favourite seems like she’s been around forever. Largest horse in the field and still a solid racer. Usually around mid-pack but struggles to have the top speed to win in any given year. Better than average starting discount. Expect a solid result.

Hearts and Minds (ASX: HM1)

• Starting Handicap: 15% discount
• Form guide: Has had a few tough runs recently, with the stewards throwing the book at them which has resulted in a large 15% discount. For the first couple of years HM1 traded at a sustained premium, however, a shocking performance in 2022 brought them well back into the pack. The mix of super trainers recently appointed a new jockey to ride this one, and we expect that it will now be more competitive.

Tribeca Global Natural Resources Limited (ASX: TGF)

• Starting Handicap: 20% discount
• Form guide: The trainer uses a specific training method for this horse, however so far it has continued to run poorly. This was compounded during the year when they sold new shares in the horse at a bewilderingly low price which many owners were not happy about. Has been a frustrating runner to back, despite the attractive handicap and likely favourable track conditions.

Platinum Capital (ASX: PMC)

• Starting Handicap: 15% discount
• Form guide: Very experienced runner with many campaigns behind it. Has not had a standout performance for a long time, as the training methods have just not suited the track conditions. We believe this is about to change. The steward's handicap of a 15% discount is immensely helpful, and this is one of our top picks. A robust performance is almost required from here, otherwise, the owners will likely start to push for a sale.

Future Generation (ASX: FGX) and Future Generation Global (ASX: FGG)

• Starting Handicap: 10-15% discount
• Form guide: Both these stablemates have a collection of star trainers behind them, but they generally finish amongst the pack. Given the starting handicaps they are likely to be very solid performers, but it’s difficult to see them having a crack for the win.

Bailador Technology (ASX: BTI)

• Starting Handicap: 30% discount
• Form guide: The trainers and jockeys have continued to do a very impressive job with this runner. They have had some very strong wins in lead-up races and remain very well-placed for the race.

Ophir High Conviction (ASX: OPH)

• Starting Handicap: 10% discount
• Form guide: Another horse with an exceptional performance history, though the last couple of years have been more mixed. A return to form for this one at some stage is almost a certainty and the handicap is as good as it’s been for a while. Definitely worth a punt this year.

VGI Partners (ASX: VG1)

• Starting Handicap: 15% discount
• Form guide: A chequered history for this one. After an exceptional performance in the unlisted fund stakes, has struggled since joining the LIC Cup. A change of trainer has helped a little, but the regular jockey has been on leave for some time. A US owner with a reputation for impatience has recently taken a sizable stake in the horse, so it could be an interesting year. Definitely one to keep an eye on.

Thorney Opportunities (ASX: TOP) and Thorney Technologies (ASX: TEK)

• Starting Handicap: 40% discount
• Form guide: The stewards continue to give these two stablemates a very generous handicap around a 40% discount. However, even at this handicap, the punters refuse to back it. The trainer charges horrendous fees, and to date, the performance has not been worth the cost. We have backed these horses for a long time but have continued to be disappointed.

L1 Long Short Fund (ASX: LSF)

• Starting Handicap: Small discount
• Form guide: This horse has been in incredible form lately, with a string of wins through outright speed. Excellent pedigree with one of the best trainers and jockeys in the country. This has not gone unnoticed by the stewards and is now carrying a handicap close to par.

ECP Emerging Growth (ASX: ECP)

• Starting Handicap: 20% discount
• Form guide: Small horse. A great long-term performer and had a great last year, after a couple of very disappointing runs. The big question is whether this horse can maintain its recent form. If so, with a low handicap it could be a very strong runner.

Ryder Capital (ASX: RYD)

• Starting Handicap: 15% discount
• Form guide: This horse has really struggled over the past 18 months, which has severely dented a previously impressive performance record. Punters are hoping that the poor form is now in the past, and RYD can find its previous speed. The trainers and jockeys are very aligned, and we believe things are on the up.

Touch Ventures (ASX: TVL)

• Starting Handicap: 50% discount
• Form guide: Former stable mate to Afterpay and every punter loved this horse when it made its debut a couple of years ago. Since then, it has been a perennial disappointment. If it doesn’t show the form it is capable of quite soon, it’s likely retirement is the best option.

Hygrovest (ASX: HGV)

• Starting Handicap: 50% discount
• Form guide: Raised and trained on an alternative farm out the back of Nimbin, this tiny horse is another that has been a disappointment almost since day one. It does have a lot of potential though. A recent change of trainer, with a promise to move to more standard training methods, may pay dividends. Worth a flutter.

Who would fill the top 3 places?

Like the Melbourne Cup, the field is wide open and we should always expect the unexpected. But we realise everybody loves a hot tip. Here are our picks. We’ve gone with one consistent performer and a couple of roughies.

Platinum Capital (ASX: PMC)

Platinum’s struggles over the past 5 years have been well publicised. Their returns have failed to match the MSCI benchmark and they have been soundly beat by their competitors espousing the virtues of quality and growth (often regardless of price). In a world of extremely low interest rates, their sensible value style failed to keep up. We think value investing is ready for a renaissance and we don’t believe for a second that these guys have forgotten how to invest.

PMC follows their flagship global fund and is a long-short global equity strategy. Given the tumultuous markets since 31 December 2021, we believe averages are hiding an even more bifurcated market than usual, which suits their strategy. Their long book is priced at 10.9 times compared to the MSCI at 15.4 times, and the manager advises that they continue to find many overvalued stocks for their short book.

For many years PMC traded at a strong premium to NTA. However, since 2019, it has traded at up to a 20% discount, and currently is trading at around a 15% discount. The pressure on Magellan Global Fund (MGF) and the likely change of structure there, increases the pressure on PMC to find a permanent solution to their discount.

The current capital management strategies of PMC have proven to be completely ineffective, and we believe it is likely the board may have to take more drastic steps.

Tribeca Global Natural Resources Fund (ASX: TGF)

This one is a bit of a roughie, and to be fair the trainer and jockey have done a fairly poor job so far with this runner. TGF has a wide mandate to invest long short in commodities, resources equities and resources credit. In a market with a wide range of valuation extremes, we believe this sector is one of the cheapest. The price you pay to back this one is high short-term volatility.

TGF floated in 2018 at $2.50, and to date those IPO investors are still well underwater, including dividends. The manager has scored a number of own goals. This includes a rather large loss on a private credit position, and a very dilutive capital raising.

So why do we still like it? It is one of the very few ways to invest in pure resources exposure. They are specialist natural resource managers, with a global mandate. TGF has significant exposures to Uranium, Copper, energy and Precious Metals, all of which we believe offer compelling value. Many of these resources are subject to a chronic supply crunch, where current spot prices are not high enough to entice a supply response, and there is an approaching supply deficit that the world will need to grapple with.

TGF currently trades on a 20% discount to NTA, which it should given its track record. One of the more significant risks for is that the manager decides to undertake another dilutive capital raising. The previous raise tarnished their reputation, and many investors are wary to own TGF due to this. Our hope is that management and the board has learnt this lesson.

Forager Australian Share Fund (ASX: FOR)

This is somewhat of a full circle bet for us. We owned this one back when it was racing in the unlisted fund stakes, before transitioning to a listed structure and the LIC Cup. Now, we own FOR again as it flags a return to its unlisted fund origins.

Forager generally invests in deep value small caps, which can make for an exciting ride through a cycle. When FOR converted to an LIC, the manager was doing it for the right reasons. They had decided that the fund was as big as they could handle for the strategy and stopped any further applications. In order to handle liquidity, they believed that an LIC was the right structure for the strategy. The type of stocks that FOR holds often do have a limited free float, and therefore the closed ended nature of an LIC and stable pool of capital did make sense for FOR.

In the almost 7 years since listing, performance has been lumpy. Their deep value style sees the manager take on companies which may have had a troubled past or are a little more difficult than average. This strategy produced excellent returns prior to listing, but with low interest rates, and the global pandemic, returns were very volatile. Initially FOR traded at a sustained premium to NTA, however fell to a discount and never really recovered. Part of the problem was liquidity, which the manager referenced to many of the original unlisted fund investors who never sold.

In October 2023, the manager advised that they would give investors the option to vote to return the fund to an unlisted structure (with a reducing exit fee). FOR currently trades at a 10% discount to NTA, thereby offering the patient investor a 10% head start over 12-18 months, assuming the vote is approved. In addition, we believe that trainers hunting ground of small cap value stocks is possibly the most hated and most ignored sector of the market right now, a combination that we find extremely attractive.

Before you invest, read this!

We encourage you to do your own research before investing in any LIC. Remember, a great LIC and a great manager is only part of the story. We also like to make sure they are trading at the right price and that the assets they are investing in are not themselves overvalued. We explain how we do this in our LIC Guide, but in the end it’s up to you to make the investment decision that’s right for you, in conjunction with your financial advisor if you have one.

If you’d like to know more about Affluence and our funds that bring together some of the best investment managers in Australia, visit our website.

Take care and all the best with your investing.