The Melbourne Cup of LICs: top picks and roughies in a shrinking field

It's Melbourne Cup day, and once again we’ve rummaged through the Listed Investment Company bargain bin to come up with our best LIC picks for the 12 months ahead. This year, the field is shrinking and there have been very few new runners emerge. So, we have dispensed with our extended LIC by LIC form guide. Instead, we look at current themes in the sector, check how last year’s predictions fared, and nominate our top picks for the year ahead, including a few roughies.

Less opportunities, but still plenty to get excited about

Back on the 18th of March this year, we wrote that it was time to put some money to work. It's fair to say it wasn't the most popular article we've ever written, but we've got a strong contrarian streak, so we rarely win the popularity contests. Since the lows of March, like much of the equities market, we’ve seen a big bounce in LIC prices, discounts have compressed and NTA’s have increased. This has led to a reduction in the number of opportunities. That’s reflected in our LIC portfolio, which has gone from around 35 holdings at the end of March, to less than 25 now.

Nonetheless, there are still some LICs trading at very attractive prices. Just less of them. Our current Affluence LIC Fund portfolio has an average discount of 17%, compared to around 25% back in March and 6-8% normally.

Because the market has run hard since late March our biggest holdings right now tend to have one or more of the following in common; lower market exposure, high discounts to NTA or a catalyst.

The shrinking LIC market

There has been, and continues to be, quite a bit of corporate activity in the sector. We hold several positions where we expect change to occur. We anticipate this activity will continue for at least another year, providing a steady stream of short term trading opportunities. There are now a range of activist investors who hold positions in multiple LICs, which is helping to nudge LIC Boards along in several instances. Thus, we expect to see the recent trend of wind-ups, conversions, and takeovers to continue.

As one example, last month Australian Leaders Fund (ALF) finally announced a proposal will be put to shareholders to convert the LIC into an unlisted unit trust, allowing investors to exit at NTA. This has been a long time coming after many years of lacklustre performance. We were one of a group of shareholders who have been agitating for this for some time. Other transactions underway include:

• Absolute Equity (AEG), which has indicated a proposal to merge into an existing unlisted fund is likely to be forthcoming.
• Magellan, who have announced a proposal for MGG. If approved, it should effectively result in the LIC being linked closely with the unlisted fund, assisting the LIC price to anchored around NTA.
• An Evans Dixon managed fund (EFF) commenced winding up in late October. Just last week, they announced two more of their LICs will delist and operate as open ended unlisted funds.

At the activist end of the spectrum, there is also further potential for consolidation. LICs managed by Wilson Asset Management recently launched takeover offers for Contango Income Generator (CIE) and Concentrated Leaders Fund (CLF). Contrarian Value Fund (CVF) is under pressure and looking like a wind-up is possible. Ellerston Capital has recently merged their global LIC with an unlisted fund, and it is likely their remaining LICs will come under pressure to do the same. Tribeca's Natural Resources LIC is under some pressure from shareholders after a misstep with one of their credit exposures, leading to a big write down. And even Templeton’s value focused LIC is considering its options after a long period of underperformance, no doubt prompted by the significant presence of another large LIC on the register.

The market for new LICs is all but extinct. But we do have one new manager looking to come to market. Existing LIC 8EC is most of the way through a wind up, but in the next month, shareholders will vote on a recapitalisation proposal from Lanyon Asset Management. We expect this to succeed, proving that there is still a little bit of life in the sector and quality managers can be supported. But it’s a tough space for new capital to be raised. The advent of quoted managed funds on ASX is likely to continue to turn the screws on the LIC sector. After all, ASX quoted funds can replicate the biggest advantage of LICs (ease of trade) while avoiding the biggest problem (discounts).

Last years' LIC picks - how did we go?

Over the 12 months to 31 October 2020, the ASX200 returned negative 8.1% (including dividends). All three of our top picks from last year, Monash Absolute Investment (MA1), Blue Sky Alternatives (WMA) and L1 Long Short (LSF) went well compared to that benchmark. Here's a recap.

Monash Absolute Investment (MA1)

Monash delivered an excellent 22% total shareholder return over the past 12 months, as the investment manager navigated pandemic markets very well. Monash is also well advanced on a proposal to convert MA1 to an exchange traded managed fund. This helped performance through the year, as the discount continued to narrow.

Blue Sky Alternatives (now WMA)

WAM Alternatives, the new name for Blue Sky Alternative Investments, delivered a 14% return in the past 12 months. This was almost entirely due to the discount gradually narrowing through the year. The old Blue Sky Alternative Assets LIC is now under the full control of Geoff Wilson’s WAM Asset Management. He’s hired a crack investment team to manage it and it will likely get a lot of attention from the WAM marketing department over the next few months. The NTA discount has narrowed from over 30% to a much more respectable 11%, and we still see some upside here.

Credit must go to the independent Directors of WMA, who negotiated a very interesting deal with the investment manager. If WMA doesn’t trade at NTA or better over the next few years, shareholders get to vote on winding it up. The Pinnacle backed Antipodes has recently announced a new structure for their LIC also linked to the average discount, and we think these types of agreements will become the gold standard in coming years to help ensure NTA discounts do not get too far out of hand.

L1 Long Short (LSF)

L1 Long Short Fund returned -7% in the past year, only just outperforming the ASX. The damage was mostly done at the portfolio level, as COVID hit many of the companies LSF owns quite hard. Having said that, this LIC is well positioned for economic recovery, continued stimulus, and a vaccine. If they’re right, LSF could have a very good year. If they’re wrong, and performance suffers again, a wind-up or conversion to an unlisted fund could be on the horizon, and investors would benefit from exiting at NTA.

Our top three picks for the 2020 LIC Melbourne Cup

As we've noted, it's a reduced field of LICs this year and it's likely to get smaller. Given that, we've abandoned the full form guide and focused just on our top picks for the year ahead.

Thorney Opportunities Fund (TOP)

This is one of two LICs run by billionaire Alex Waislitz. Short term performance has not been great. Longer term results have been much better. TOP is currently trading at a discount of over 20% (and was very recently at a greater than 25% discount), which cannot continue and will need to be rectified by the manager. The recent success of stablemate TEK shows what can happen when an investment strategy is paying off. TEK has delivered total returns of more than 24% over the past year. We see a similar or better outcome is possible for TOP, especially if value stocks finally get a bid, which will likely help to narrow the discount.

Three roughies – Cordish Dixon I, II and III

It's hard to think of a more contrarian bet than these three LICs. Part of the listed Evans Dixon stable, they have certainly suffered some reputational damage over the past couple of years, as the manager has had to deal with several issues. The share prices of CD1, CD2 and CD3 have suffered, as a steady stream of Evans Dixon clients have presumably been quietly selling down their exposures. This has led the three LICs trading at discounts of 40-55% to their underlying NTA.

While listed stablemates URF and NEW have genuine balance sheet issues, and will probably require major asset sales, we believe CD1, CD2 and CD3 are not in that category. In fact, we think they provide some of the best potential returns of any LIC over the next few years. All three LICs are effectively overseen by the US based Cordish family, who co-invest alongside the LICs. Each LIC holds a diversified mix of US private equity investments through a range of underlying managers. There is no direct debt in the funds, and two of them have net cash.

There is, of course, a catch. All three LICs have very low liquidity. The information provided by the manager for these LICs is limited, and they need to do much better. But based on our work, we believe the current prices are extremely attractive for those with a 3-5 year investment horizon. 

Two stayers with poor recent form

One of our favourite plays in the LIC sector is to back a manager with an exceptional long term track record, but poor recent performance. The reason is simple. Performance, or at least outperformance, tends to be cyclical. Great managers don't forget how to invest. But sometimes their style just doesn't suit the current market.

Two of our biggest LIC holdings right now are the two VGI Partners LICs, VG1 and VG8. VG1 invests in global equities. VG8 is focused specifically on Asian equity markets. At about the time VG1 floated, the manager, VGI Partners, was quite excited about VG1 being an aggressor to mop up LICs trading at unsustainable discounts. Instead, VGI has succumbed to that very problem. Despite an enviable long term track record, these two LICs are trading at big discounts.

The departure earlier this year of Doug Tynan from the investment team has not helped sentiment. But we believe the VGI Partners team have not forgotten how to make money, and we're picking they will be able to outperform over time, particularly if markets remain volatile. In addition, VGI Partners have spoken at length about making sure their LICs are as shareholder friendly as possible and chief stock picker Rob Luciano seems determined to close the discount. It is not palatable for VGI, who have built a reputation as a short seller, to have LICs trading at 15-25% discounts for too long. VG1 has traded in the past at a premium to NTA and we believe, as do VGI, that it can do so again in the future.

Final words

So, there you have it. A quick wrap of the sector and some of our favourites for the year ahead. Like all investments, it is best to do your homework properly before buying any LIC. We suggest you consider only quality LICs with proven managers who have performed well in the past. Ensure those LICs hold assets you like and have an investment strategy you understand, with an appropriate management structure in place. Understand how an LIC will fit into your portfolio and how you expect it to assist you in achieving your investment goals. Most importantly, try to buy at the best possible price you can, relative to the value of the underlying assets and the trading history of the LIC.

If you'd like to know more, we wrote this wire earlier this year, with our thoughts on how to invest in LICs.