When do you pick a good LIC to buy?

Founder and Publisher of the Switzer Report
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Listed investment companies (LICs) have been in the news lately, with Magellan recently bringing a listed investment trust to market that will pay no commissions to advisers and brokers for recommending these vehicles to their clients. And it coincided with our Listed Investment Conference over the past two weeks, where we featured the local king of LICs, Geoff Wilson of Wilson Asset Management.

It also comes at a time when a lot of smarties have been telling me that LICs selling at a discount look like good value. The most well-known of these was top ex-Perpetual equities picker and founder of 452 Capital, Peter Morgan.

I was even surprised when my colleague, Paul Rickard, during our Investment Master Class, which we held at our conferences in Sydney, Melbourne and Brisbane, admitted that he buys LICs but only when they’re trading at a discount.

Before moving on, let’s look at this key issue for LICs — when should you buy them?

A simple rule has to be whether the LIC is trading at a premium or a discount. As I said, Paul is only interested when the LIC is trading at a discount and Geoff reinforced this view, admitting that if his daughter asked him which of his LICs he’d recommend, it wouldn’t be his famous WAM Capital because it’s trading at a big premium (that means the market values the assets of the LIC higher than their true value or Net Tangible Assets).

Geoff made the point that his whole life he has “wanted to pay 80 cents for a dollar!” And that’s what he thinks a good LIC at a discount represents. And there can be a pattern with some LICs, as the chart below of Argo Investments (ARG) shows:

Periods of discounts are eventually followed by periods where the LIC or ‘stock’ trades at a premium. Of course, not all LICs beat the discount tag but others do, and in the modern context of unbelievably low term deposits, those LICs that have been big dividend payers should be making appeal.

Over the past year, I saw my ETP (Switzer Dividend Growth Fund or SWTZ) do what a LIC at a discount can do. SWTZ listed at $2.50 and, with all the market fear around, went as low as $2.23 on December 21 last year. If someone had bought it at that time primarily for its yield (which is its main function), they would’ve pocketed a capital gain of 12% plus three payments, totalling 15.3 cents or nearly 7%, with one more quarterly payment to go!

This table shows an exceptional year for yield for SWTZ, which was helped by the Bill Shorten impact on companies that unloaded their franking credits. But even without these ‘gifts from Bill’, a fund like SWTZ should be a 5-6% dividend payer before adding in the tax pluses from franking. That’s its goal.

I’m sure some smarties will now be looking at LICs that pay good income because of the low level of interest rates on term deposits. For those who can live with the turbulence of a stock market, challenged by Donald Trump, his trade war, recession headlines out of the bond market and all the political shocks, such as Brexit which are becoming economic shocks, a collection of income-paying funds could be the way to go.

One LIC trading at a discount is the Contango Income Generator (or CIE), which closed the end of July trading at 81.5c compared to an NTA of 96.1c. While it’s overall share price performance has been disappointing, its yield delivery has been good (returns below to 31 July 2019).

I can see the good sense for someone who’d call themselves income-chasers to invest in a number of income-promising funds such as SWTZ, CIE and the likes of Vanguard’s High Yield fund, VHY, which has had a nice run lately.

Low-term deposit rates are here for some time and investors will have to balance up their need for income and their preference for seeing their capital grow.

Checkout this view on intertest rates going forward from The Guardian, only on August 10.

“The era of low interest rates will last for at least another 20 years, despite gently rising official borrowing costs in the coming years, one of the Bank of England’s leading policymakers has forecast,” wrote the newspaper’s Larry Elliott.

“In a valedictory interview before leaving Threadneedle Street’s monetary policy committee (MPC) at the end of the month, Ian McCaffery said structural changes in the global economy meant UK borrowers and savers should get used to interest rates being “significantly” below the 5% average in the 10 years leading up to the financial crisis.”

This chart captures our term deposit dilemma:

I think it’s dangerous to invest without diversification so having a number of income-paying funds (LICs and ETFs) is how I’ll be playing my pursuit for income. And if I can pick up some capital gain to boot, then maybe getting to know some LICs that deliver dependable dividends, which are trading at a discount, could be a smart play.

I don’t think we’re at the end of this bull market but we are in the end-stage, so playing a different game makes sense. My different strategy is to be even more exposed to reliable income payers because I’ve learnt not to worry about the capital but more about the quality of my investments and their ability to keep delivering me bankable income.

Capital gain looks good but unless you take profit, it can go as quickly as it comes. That’s why I play an income game for the core of my portfolio.


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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