The 'Melbourne Cup of LICs': Our form guide and three favourites

What if there was a Melbourne Cup of Listed Investment Companies? Who would make the starting line? Who would win? We have analysed the field of well over 100 LICs. Here are our 24 starters for the 2019 “Race that Stops the Investing Nation”, and our three winners.

The Melbourne Cup of LICs

We are proud to present our third annual form guide for the Affluence LIC Cup. The LIC Cup is possibly even more important than the Melbourne Cup. There’s approximately $44 billion of investors (hopefully not gamblers…) money at stake in the LIC 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 importantly hasn’t been hit too hard with a weight handicap from the stewards. To win the Affluence LIC Cup, an 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 weight handicap (starting discount or premium to NTA).

Last year’s race was very different to this year. The 2018 LIC Cup was run on a very soggy track (falling equity markets). However, the stewards had maintained fairly average handicaps last year (discounts to NTA were reasonable). 

This year, the track is looking lightning fast, with the ASX 200 up over 20% this calendar year and the S&P 500 near all time highs. However, the stewards appear to have lost the plot and drastically reduced handicaps (increased discounts) across the board. This could perhaps make it a good time to “have a punt” on a few LICs.

Who would make the cut?

We have analysed the field of over 110 LICs, and here, in no particular order, are our 24 starters for the “Race that Stops the Investing Nation”. Don’t feel bad if your favourite “horse” is not in the list. The quality of LIC runners is very high right now and there are many more that could have made it into the field this year.

Who would fill the top 3 places?

Like the Melbourne Cup, the field is wide open this year, and you should always expect the unexpected. But we realise everybody loves a hot tip, so here are our picks for the year. 

All three are currently key holdings in our LIC portfolio.

Monash Absolute Investment Company (ASX code: MA1)

MA1 is one of the smaller LICs and is managed by Simon Shields and Shane Fitzgerald of Monash Investors. MA1 listed in April 2016 off the back of some excellent performance in their unlisted fund which uses a very similar strategy. Unfortunately, this corresponded with the start of a period of underperformance. The LIC quickly came under pressure and started trading at an increasingly large discount.

The management team and board tried various initiatives to close the discount, with not much success. Even this calendar year, when the managers have achieved a fantastic portfolio return of 36%, the high discount persisted (above a 20% discount to NTA). In August 2019 the company announced that they proposed to restructure MA1 from an ASX listed LIC to an ASX Exchange Managed Traded Fund (ETMF). Unlike a closed-ended LIC, an EMTF is an open vehicle that uses market makers to ensure it trades in a very tight band around NTA.

This proposed solution would allow investors to access the managers' strategy through the ASX. It would also permanently eliminate the shares trading at a substantial discount. The main disadvantage of this proposal is for the investment manager, as they lose the significant asset of having a fixed amount of capital to manage. Monash Investors have put shareholders’ interests above their own, and we commend them for this decision.

There are a few hurdles for the proposal to be completed, with the main one being ASIC has put a freeze on new ETMFs until it completes a review of the sector, which is expected to be completed in the next few months. Hopefully, common sense will prevail as this proposal is clearly in shareholders’ best interests. There are also several steps that need to be taken to complete the transaction, including a shareholder vote.

To us, the most surprising part of all this is that even with this clearly stated intention to get rid of the discount permanently, the shares are still trading at a 10-15% discount to NTA. There is still market risk, however this is the case with all similar ETFs and managed funds. There is also the risk that the proposal does not proceed, for example due to the ASIC review or investors not approving the vote. However, based on our last count, approximately 27% of the company is now held by substantial investors (those who own more than 5% of total shares). We believe these holders now expect that one way or another, the discount gap will be closed. Therefore, even if the current proposal did not proceed for some reason, these investors will be active in demanding some other solution to achieve the same result.

Blue Sky Alternatives Access Fund (ASX code: BAF)

BAF was one of our top pics last year, and while it has taken longer to play out than we expected, it remains one of our top picks today. BAF has traded at up to a 35% discount to NTA over the past 12 months, although this has recently improved to around a 22.5% discount.

The discount does not reflect portfolio performance; the BAF portfolio has returned 6.8% over one year and 7.2% per annum over three years. Nor is it because of high gearing, as it currently has approximately 25% of assets in cash. We believe the key reason the discount persists is that the name of the LIC includes “Blue Sky”.

Over the past 12 months, while not much has happened for BAF, there have been big changes for the investment manager. Blue Sky Alternative Investments Limited, the parent of the manager, had administrators appointed during the year after defaulting on a convertible note issued to Oaktree. It appears likely that all equity in this company is lost, and the manager will ultimately end up being owned and controlled by Oaktree. While this is bad news for the investment manager shareholders, there is very little direct impact on BAF.

Part of our investment thesis last year was that it was likely a new investment manager would be appointed for the LIC. During the past 12 months, the independent directors of BAF have worked very hard to try and make this happen. The board recently announced that if they cannot come to a satisfactory agreement with the current relevant parties soon, they will consider other options available to them, including a windup and return of capital. In our view, that would be the best course of action.

Reading between the lines, it would appear that we are now at the pointy end of a decision being made. Whether it’s the appointment of a suitable new manager or a windup of the vehicle, we believe the current 20% plus discount on offer is very attractive. Some of the underlying assets are illiquid and may take an extended period to realise. However, there is 25% cash which could be distributed very quickly. In addition, a holding in the Blue Sky Water Fund represents another 25% of BAFs assets. This stake has previously attracted offers at a premium to book value, and we believe it could be very attractive to other water rights investors and investment managers.

L1 Long Short Fund (ASX code: LSF)

One of our core aims in constructing portfolios is to identify top tier managers. We find they often have a number of similar attributes; they have outperformed a fair benchmark over a reasonably long timeframe, they usually outperform in down markets, the portfolio managers have significant equity in the investment manager and underlying investment strategy, the portfolio managers have extensive history together and are responsible for the track record, and they have wide asset allocation discretion and have a fairly unconstrained investment strategy.

The above attributes summarise L1 Capital pretty well. Their long only unlisted fund has outperformed by 3% per annum over 12 years. But like virtually all great managers, they also have periods of poor performance. This was the story with the L1 Long Short Fund, which listed in April 2018 just as the investment manager slipped into a period of poor performance. Leading up to the IPO, the unlisted fund had achieved 39% per annum returns over the prior three years. Through a combination of the poor investment performance since listing and the obvious disappointment of investors, the share price fell from $2.00 at IPO, to a low of $1.27 in late 2018.

One of our favourite situations is when a great manager goes through a rough performance period. We believe this is an opportune time to invest (or top up). This situation is even better when you can access the strategy through an LIC at a substantial discount. The recovery is already well underway, with the NTA up over 20% off its lows and the share price back to $1.60. The current discount to NTA is around 12%, which we believe can continue to recover if the good recent performance continues.

Before you invest, read this!

We encourage you to do your 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’re trading at the right price and that the assets they are investing in are not themselves overvalued.

If you would like to know more, Affluence recently presented at the ASA Listed Investment Company Showcase events in Sydney, Melbourne and Brisbane along with an exceptional line up of LIC managers. We spoke about the features we like about the LIC market, the key things we look at when assessing a LIC and how they might fit into your portfolio. We also looked at a variety of investment themes you can access through LICs and explained why the most exciting opportunity in the current LIC market is the ability to access a wide range of LICs at discounts to NTA well above average. Click here to watch the 30 minute presentation in full.

Take care and all the best with your investing.