Opportunities in the market carnage

Co-founder of the Switzer Report
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If there is a positive in the current market mayhem it’s that mispricing opportunities abound.

And I am not talking about stocks that are perceived to be “cheap” relative to an assessed broker valuation or earnings multiple, or “cheap” relative to their peers. That’s a story for another day.

Instead, I want to focus on companies and trusts that are trading below what they are actually worth, or in some cases, trading above what they are worth. Importantly, ‘what they are worth’ is not in doubt – it can be estimated with a high degree of certainty.

Of course, I am talking about some listed investment companies (LICs) and listed trusts (LITs). These can invest in Australian shares, international shares, fixed income and property, delivering investors easy access to different asset classes and helping to create diversified portfolios. In volatile markets, their trading price on the ASX often bares little resemblance to their underlying value. This creates the mispricing opportunity.

The opportunity may not be to just buy or sell the LIC/LIT. It could be to switch from one LIC to another, or from an actively managed LIC to a passively managed ETF to deliver a better overall return.

Here are some current opportunities in Australian shares and “risky” fixed interest. There are also opportunities in international shares. As the market is volatile, please review the prices and valuations before undertaking a trade.

  1. Broad based, large cap Aussie equities

Remarkably, the prices of the three major broad based Aussie listed investment companies, the $7.7bn Australian Foundation Investment Company (AFIC, trading under stock code AFI), the $5.9bn Argo Investments (ARG) and $3.0bn Milton Corporation (MLT) went up last week. AFI added 12c to $6.48, Argo 1c to $8.17 and Milton 2c to $4.44. This was in a week that the share market lost exactly 3.0% (after taking into account the impact of dividends and several stocks trading ‘ex-dividend’).

Two of these stocks are now trading at a material premium to their NTA (net tangible asset value).

The following table shows the actual premium/discount to NTA as at 28 February and an estimation of the premium/discount at 7 March. The former is based on the company’s month-end NTA, while the latter is an estimate I have calculated based on the movement in the S&P/ASX 200 Accumulation index over that period. It is not going to be too far out because these companies pretty closely track the performance of the overall market.

The trade is to sell these stocks and buy passive, index tracking exchange trade funds such as VAS (Vanguard’s ETF that tracks the S&P/ASX 300), or IOZ from ishares or STW from SPDR (the latter two track the S&P/ASX 200.)

AFIC, Argo and Milton broadly track the performance of the S&P/ASX 200 index. In recent years, they have underperformed on a relative basis, so approaching a premium of 5% makes them a definite sell and if maintaining exposure, to switch into “guaranteed” index performance through the ETF. The case for Milton is less clear, but it has been the “underperformer” of the three in that it more traditionally trades at a discount to NTA. It also has way overweight holdings in W H Soul Pattinson and Brickworks Ltd.

  1. Bank Hybrid Securities

The prices of bank hybrid securities got hammered late last week. This followed the fall in the prices of bank ordinary shares as recession fears grew and commentators focussed on the impact of very low interest rates on net interest margins and a possible blow out in bad debts. A deterioration in the professional investment markets of credit spreads as a “flight to safety” rally took hold also impacted.

Trading margins in the secondary market for bank hybrids blew out by more than 60bp to around 3.5% to 3.6%.

If you were considering making an investment in two current issues, Macquarie Capital Notes 2 (which are priced at a margin of 2.9%) or National Australia Bank Capital Notes 4 (which are priced at a margin of 2.95%), don’t. You can do a lot better by investing directly on the ASX  into existing issues– have a look at CBAPG, CBAPH and most other bank hybrid securities. And to be clear, I am not saying that this is the end of the movement in spreads. Rather, these two primary market issues are now mispriced.

  1. Risky fixed interest securities

The “flight to security” saw spreads on riskier fixed interest securities blow out considerably. Although treasury bond yields fell, yields on lower rated and unrated corporate securities rose.

This creates a “mark to market” risk for the listed credit funds, and their NTAs fell marginally over the week. In the medium term, if the increase in trading spread translates into increased borrower defaults (which is what the market is effectively “saying” – or more correctly,  “fears”), then actual losses will occur .

As at the close on Friday, some of the listed credit funds had moved to trade at a discount to their NTA. The following table shows three of the more prominent funds.

Potential investors in this part of the market should keep an eye out for NTA updates and price moves – there may yet be some considerable opportunities with these funds.


Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.

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