Recent equity market volatility has presented investors with opportunities to buy listed investment companies (LICs) at a discount to their underlying net tangible asset (NTA) backing. 

To help make an informed investment decision, it is important not only to look at the NTA of a LIC, but also to assess the company’s investment strategy, long-term investment portfolio performance, quality of the investment manager, history of paying fully franked dividends and how the company communicates and engages with its shareholder base. 

Understanding NTAs

In their simplest form, the NTA per share of a LIC represents the total assets of a company, less liabilities and intangible assets (such as goodwill), divided by the number of shares on issue. 

The NTA represents the true underlying market value of the company’s assets, calculated in accordance with the Australian Accounting Standards, at a point in time. 

A LIC is a public company, has a board of directors, corporate governance and its shares are traded on the Australian Securities Exchange (ASX). 

At times, the LIC’s share price can fluctuate above or below its underlying NTA value. The NTA of a LIC is announced on the ASX to shareholders each month. 

The NTA of a company is a “right now” reflection of where the assets of the LIC are invested, how much those investments and other assets the company holds are worth, less any associated liabilities for the company. 

Companies often report a pre-tax and post-tax NTA, showing shareholders the value of the company excluding current or deferred tax liabilities and assets as well as the value of the company’s assets if those tax liabilities were to be paid.

Fundamentals first

NTAs are a point-in-time reference for the value of a LIC and should always be the first step for investors when evaluating the company. 

However, NTAs are a small slice of the pie when it comes to making an informed investment decision with LICs. It is important also to consider:

• the company’s historical investment portfolio performance, which may be a measure of the investment manager’s ability to perform compared to its relevant index on a like-for-like basis (noting that past performance is not indicative of future performance)
• the NTA growth of the company, as this demonstrates the realisable value of the company after expenses, fees and taxes
• the total shareholder return (TSR), which measures the tangible value shareholders gain from share price growth and dividends paid over the period, before the value of any franking credits distributed to shareholders through fully franked dividends. 

At the end of the day, TSR is the true return for shareholders of a LIC, as it represents the tangible value they are able to receive for their shares, including dividends paid by the company. 

The TSR can often be impacted by a company’s shares trading at a discount or premium to its underlying NTA, so it is important that you consider all three measures of performance for a LIC when making an informed investment decision.

Why are some LICs at premiums and others at discounts?

A LIC can trade at a premium or discount to its underlying NTA. An investor, for example, might be able to buy $1 of assets for 80c – or sell $1 of assets for $1.20. 

Whether a LIC trades at a premium or discount to its NTA can be influenced by a number of factors including, but not limited to:

• short-term falls in domestic or global equity markets and overall equity market volatility
• the performance of its investment portfolio
• its history of fully franked dividend payments
• its marketing and communication strategy 
• the overall experience of its investment management team and board of directors.

Buying shares at a discount to NTA means you pay less today than what the company’s underlying net assets are valued at. It can give shareholders access to a portfolio of investments for less than what they are worth, but investors need to be confident that the discount can dissipate over time in order to capture or realise that return. 

Buying shares at a premium, however, means you pay more today for a company than its underlying net assets are worth. 

LICs can trade at a premium when they pay a consistent and growing stream of fully franked dividends, have a track record of long-term investment portfolio performance, treat shareholders equitably and communicate consistently and effectively with their shareholder base. 

The risk is whether that premium to NTA will be maintained or grow over time. Paying $1.20 today for a LIC which has a NTA of $1.10 can quickly lead to an investment loss if the share price of the LIC trades back to its NTA value or goes to a discount.

Putting this information into practice 

The closed-end structure of a LIC provides investors with the ability to buy shares at a discount or potentially sell their shares when they are trading at a premium to their underlying net asset value. 

However, it is important to not get caught in a “value trap”, referring to situations where a LIC represents good value with its discount to NTA, but falls short of expectations if that discount persists or worsens over time. 

There are several risks to consider here, as a LIC may continue to trade at a discount to its underlying NTA for a long period of time. Or the share price premium to NTA of a LIC may evaporate quickly for no other reason than a change in market sentiment or equity market volatility. 

Investors should always ask: is there a realistic expectation that the discount will close? Has the LIC traded at NTA or a premium to NTA in the past? And do you believe that the investment manager and the company will be able to close the discount and continue to perform for shareholders?

We believe there are four critical elements of a successful LIC, including a strong record of investment portfolio performance, paying a stream of fully franked dividends, treating shareholders equitably and with respect, and strong shareholder communication and engagement. 

It pays to have conviction and take a holistic approach when assessing whether a particular LIC is right for you.

DISCLAIMER

Wilson Asset Management and its related entities and each of the respective directors, officers and agents (together the Disclosers) have prepared the information contained in these materials in good faith. 

However, no warranty (express or implied) is made as to the accuracy, completeness or reliability of any statements, estimates or opinions or other information contained in these materials (any of which may change without notice) and to the maximum extent permitted by law, the Disclosers disclaim all liability and responsibility (including, without limitation, any liability arising from fault or negligence on the part of any or all of the Disclosers) for any direct or indirect loss or damage which may be suffered by any recipient through relying on anything contained in or omitted from these materials.

This information has been prepared and provided by Wilson Asset Management. To the extent that it includes any financial product advice, the advice is of a general nature only and does not take into account any individual’s objectives, financial situation or particular needs. Before making an investment decision an individual should assess whether it meets their own needs and consult a financial advisor.