After the surprise election win by the Coalition in May, many investors expected a return to favour for ASX LICs. Prior months of worrying about the uncertainty of Labor’s proposed policy changes to franking credits had clearly weighed on the LIC sector.
Discounts to NTA on popular LICs such as Australian Foundation Investment Co. Ltd. (ASX: AFI) and Argo Investments Limited (ASX: ARG) had been widening. You can view the magnitude of the discounts widening for the first four months of 2019 in my Rask Media article here.
Let’s now examine why investors have been hesitant in buying LICs after the election. Whilst many have headed higher, as a general comment I am referring to them lagging ASX ETFs, which seem to have been growing in popularity.
I am also noting that the LIC’s discounts to NTA haven’t tightened like some expected. Many investors expected such a discount tightening trend if the Coalition won the election. Here’s a video explaining the difference between LICs and ETFs:
LICs: Underwhelming Performance
It has been one of the toughest periods we have seen for active fund managers in terms of performance versus standard benchmarks. This a global trend in which ASX LICs have also become swept up in.
The older LICs that usually invest in our larger companies are often very dividend-focused, favouring more mature companies. These shares have tended to lag in performance as investors show more of a preference in chasing high growth companies.
Small-Cap and Global LICs Also Struggling
LICs that specialise in smaller companies have mostly left out owning the high flying growth stocks. Some of these LICs are benchmarked to the S&P / ASX Small Ordinaries Index (INDEXASX: XSO). If a LIC’s portfolio manager hadn’t owned “WAAAX” shares (WiseTech, Appen, Afterpay, Altium and Xero) over the last financial year it has made it very difficult for the LIC to keep up with this benchmark.
Global LICs have faced a similar theme in terms of owning high growth tech shares. Decisions to underweight this category of the market has led to underperformance. Venturing outside of the US market has also generally hurt performance since the GFC.
ETFs Winning The Popularity Contest
For the time periods that investors usually look at, ETFs that simply track popular equities benchmarks have beaten LICs in most cases. Not only that, competition is ensuring a wide choice of ETF products are available with downward pressure on fees.
An example of such competition was seen in June 2019 as ETF providers tracking the ASX equities benchmarks were cutting their fees.
Too Much Supply?
About a decade ago we had less than 50 LICs on the ASX. The number was higher a couple of years before that but many were wound up or taken over during the GFC.
Now we have more than 110. I would like to give the precise number here but I have trouble keeping it up to date as more still seem to pop up!
Marketing of a LIC IPO can be quite aggressive, however, demand on the secondary market (the ASX) can suffer over time as the marketing hype fades away.
Tax Loss Selling?
Another headwind towards the end of the 2018/19 Financial Year for LICs may have been additional tax-loss selling pressure. Due to some of the poor performances and discount widening it is quite possible some investors threw in the towel. Taking a tax loss on certain LIC investments may have proved tempting if investors chalked up gains elsewhere in their portfolio.
Conclusion
I expect certain factors above to be more temporary. Obviously, we have passed the tax-loss selling period. In regard to LIC supply over the next year, I suspect things should cool down. The tough financial year in 2018/19 for LICs should make potential IPO investors think twice.
Issues regarding lacklustre performance and high-cost structures of many LICs may be more structural problems to contend with. The best answer to this might be the saying that “the cure for low prices is low prices”. By that I mean the larger discounts to NTA are beginning to offer some attractive entry points where outperformance can be generated. The dilemma, however, is that if we experience an environment of falling share prices then such discounts may well get wider.
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Disclosure: At the time of publishing, Steve Green does not own shares in any of the companies mentioned above.
