Tuesday, December 12, 2006

Listed Investment Companies (LIC's)

One sectors of the Australian Stock Exchange I find fascinating is the Listed Investment Companies. There have been a plethora of new Listed Investment Companies in recent years and there are the more established stalwarts like Argo (ARG) and Australian Foundation Investment Company (AFI) among others.

Listed Investment Companies are deceptively easy to value as their Net Tangible Assets are published to the stock exchange every month. It is then a simple matter of comparing the NTA (either before or after tax depending on your preference) to the current price to determine the discount or premium. As most Listed Investment Companies hold only listed investments, their NTA is calculated using the current market price of all of the securities they hold (plus some cash and cash equivalents).

If for example a LIC is trading at $0.80 and the latest NTA is $1.00 after allowing for any tax payable, it is then a simple matter to buy $1.00 of listed securities for $0.80. As a value investor it would easy easy to buy shares in the example company for a sure profit of 25% (a 20 cent return on an 80 cent investment). If one were to buy a selection of such companies one would almost certainly profit from the exercise.

However, there are some gotchas.

The first problem is that the company in question may trade at a discount for a long period of time - maybe indefinitely. However, history shows that these companies trade at lower valuations during stronger markets as investors believe they can do better by picking stocks for themselves. This implies that such a discount would reduce or disappear under less favorable conditions.

Secondly, some of these companies have what could be considered excessive investment management fees. You should always check what the arrangement is with the investment manager. Fees of 2% of assets plus an out-performance fee are not unusual (check for catchup in performance from previous years before an out-performance fee is paid). For this type of fee one would expect to get outstanding performance. A languishing share price may be an indicator that this is not the case.

Investment management is crucial in these companies. Do they have a strong track record, particularly in both strong and weak markets? If you are planning on holding this company while you wait for the difference between price and NTA to reduce, you want to make sure the reduction is not due to a decreasing NTA.

Lastly, as with any investment in the Australian stock market, make sure you do your homework. Check the recent announcements to find out if there is any corporate activity (like a capital return or rights issue) or any other news which may be having a dampening effect on the share price.


Anonymous said...

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