Guided Investor

How to buy a cheap listed investment company (LIC)

Listed investment companies or LICs offer a unique investment structure whereby they are a closed pool of assets. This means that when you buy into an LIC, the fund isn’t growing, you are simply buying someone else’s share of the assets.

This structure can have a number of benefits over a more traditional style open-ended investment. For example, in times of a market crash, when a lot of investors sell down their investments to cash in panic, the manager of the LIC doesn’t have to convert holdings to cash to fund the redemptions. They can remain invested and capitalise on the cheap stock prices.

However, the key advantage that we want to look at today is the ability to buy a cheap LIC. That is, at certain times you have the opportunity to own the basket of assets for less than the sum of all the individual holdings. Let me explain.

When considering investing in an LIC, you should consider the funds net tangible assets (NTA). The NTA is the value of the LIC’s total assets less the value of its intangible assets and the value of its liabilities (NTA = Total Assets – Intangible Assets – Liabilities). Or, in more simple terms, you can consider the NTA as the combined value of the underlying holdings per share on issue.

The fund manager will quote the NTA to the market on a regular basis. Some managers do this daily, some weekly and some monthly. Frequency is up to the discretion of the manager.

As LICs are a closed structure, the share price of the LIC can vary from its NTA. If the NTA is more than the share price, it is said to be trading at a discount. If the NTA is less than the share price, it is said to be trading at a premium.

To buy a cheap LIC, you are looking for funds that are trading at a discount. This means that you are buying a share of assets for less than what the actual assets are worth. Or, put another way, if you bought all of the underlying holdings individually, it would cost you more than buying them collectively through the fund.

For example, if the LIC is trading at a 10% discount to it’s NTA and the stock price is 90 cents, this means you are getting $1 worth of assets for every 90 cent investment you make. Pretty cool right?!

There are several reasons why an LIC might be trading at a discount to its NTA. Sometimes, having that discount there still doesn’t mean it’s a good buy. Therefore, it’s important to consider why the discount exists.

Some of the key reasons why a discount can exist include the following:

  • Historical performance. If an LIC has historically performed poorly then it will often trade at a discount to NTA as investors have lost faith in the manager and expect the NTA to continue to fall.
  • Poor capital management. Sometimes managers issue new shares in the LIC to grow the size of the fund. If the issue is done below the NTA, this is dilutionary for existing holders of the fund.
  • Options. Check for outstanding options and the issue price. If the option is exercised at a price below the funds current NTA, again this is dilutionary.
  • Market sentiment. The general market sentiment (think investor confidence) can often impact the discount or premium of an LIC. When investors are fearful, a large number of LICs will often trade at a discount as investors pull their cash out of the market and opt for more defensive assets.

Every so often you will come across a golden nugget where it’s a fantastic manager trading at a discount to its NTA. This can be a great investment! As a bonus, managers will often take steps to close the gap between the share price and the NTA by buying back shares on market which is accretive to earnings.

Some LICs do tend to consistently trade at a discount to their NTA. Given this, it can be worthwhile to look back on the history of the LIC over time to determine if the discount is an anomaly or the norm for that fund.

You may also come across a pretax and post-tax NTA. The figure which you use for comparison purposes really depends if it’s a fund that actively trades or one that adopts more of a buy and hold strategy. If it actively trades, compare with the post-tax NTA as it is likely that the tax payable will be realised. If it’s a fund that rarely trades, compare using the pre-tax NTA as the capital will not likely be realised.      

So, while it is good to look for a “cheap” LIC to invest in, you need to make sure it isn’t cheap for a reason. Similarly, just because an LIC is trading above it’s NTA, doesn’t mean you shouldn’t buy it. Some LICs continually trade above their NTA consistently for numerous reasons.

Disclaimer

The information in this website is for general information only.

It should not be taken as constituting professional advice from the website owner – Guided Investor as Authorised Representative of Symmetry Group (AFSL 426385)

You should consider seeking independent legal, financial, taxation or other advice to check how the information relates to your unique circumstances.

Guided Investor is not liable for any loss caused, whether due to negligence or otherwise arising from the use of, or reliance on, the information provided directly or indirectly, by use of this document.

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