Originally published by Cuffelinks
Our key measure for assessing listed investment company (LIC) performance is total portfolio return, being growth in pre-tax NTA plus dividends. However, we also look at reported earnings as they are a key driver of dividend payments.
LIC dividends hold up despite earnings pressures
For the reporting season recently finished, 14 of the 24 LICs we cover that reported full year results saw earnings decline due to lower dividend income (in the first half of the financial year), particularly for those LICs that have capital account status. There was also lower portfolio capital appreciation for those LICs that report changes in portfolio value as part of their earnings. Dividend income rose in the second half of the financial year due to a recovery in dividends from the resources sector and dividend increases from many large industrial stocks, particularly in the Healthcare sector. The top two performing LICs from a portfolio returns perspective,Australian United Investment (AX:AUI) and Diversified United Investment (AX:DUI), both reported higher earnings.
Despite some earnings pressures, there were few reductions in dividends paid by LICs for the FY2017 period, as most LICs have a level of profit reserves that enables them to smooth dividends by holding back when profits are strong. There were four LICs that reduced dividends, seven held flat and 12 increased. Amongst the four largest LICs, Australian Foundation Investment (AX:AFI) held its dividend flat, Argo Investments (AX:ARG) and Milton Corp (AX:MLT) delivered modest increases, and Djerriwarrh Investments (AX:DJW) reduced its dividend due to a decline in dividends received and lower options income.
Most of the dividend increases came from LICs that invest in the mid small and micro cap space. Standouts were Perpetual Equity Investment Company (AX:PIC), which increased its total FY2017 dividend from 2.8 to 4.7 cents per share, fully franked, and QV Equities Ltd (AX:QVE), which increased from 3.3 to 4.0 cents per share, fully franked. Both LICs reported higher earnings and good portfolio returns. There were increases from the Wilson Asset Management LICs, WAM Capital Ltd (AX:WAM), WAM Research (AX:WAX) and WAM Active (AX:WAA). The Contango managed LICs, Contango Microcap (AX:CTN) and Contango Income Generator (AX:CIE) also increased dividends but we have some concerns about the sustainability of the CTN dividend given poor portfolio performance.
Top performing LICs at a discount
Three Australian large cap focused LICs have delivered the best portfolio returns (pre-tax NTA plus dividends) in this sector over five years. At the end of July 2017, all were trading at discounts to pre-tax NTA. Whitefield (AX:WHF), Diversified United Investment Ltd (AX:DUI), and AMCIL (AX:AMH) have delivered five-year returns in excess of the S&P/ASX 200 Accumulation Index five-year return of 10.7% p.a. and all have at least matched the 5.1% three-year return from this index.
Whilst these LICs are currently trading at discounts, they have all traded at discounts on average over the past three years, so there is no guarantee the discount will be eradicated. Catalysts for narrowing in the discount could include continued good portfolio performance or increased marketing and investor communication by the LICs. Here are further insights into these top performers:
Whitefield (ASX:WHF) – exposure to Australian Industrials
Whitefield (AX:WHF) is externally managed by the White Funds Management Group, but has the appearances of one of the older style LICs, having been founded in 1923. Its management expense ratio is relatively low at 0.37%. WHF uniquely only invests in Australian Industrial shares, resulting in lower relative volatility by excluding resources shares. WHF has a proprietary data base and structured quantitative analytics framework which provides a unique platform to assess stocks and implement its investment strategy. WHF has a diversified portfolio containing more than 160 stocks, although its top 10 stocks account for 46.6% of the portfolio, broadly in line with the benchmark index.
Performance tends to track the S&P ASX Industrials Accumulation index, with the portfolio having a low tracking error, although its beta is slightly above market. With no ETF that specifically provides Industrials exposure, WHF is a cost-effective option for investors looking for this type of exposure. The share price discount to pre-tax NTA of 6.8% at 31 July 2017 is broadly in line with the three-year average discount and represents a reasonable entry point for long-term investors. The company has paid a 17 cents per share p.a. dividend since FY2009. While dividends have been consistent, an incremental increase in dividends may assist with narrowing the share price discount to pre-tax NTA.
Diversified United Investment (ASX:DUI) – Australian large-caps with some international
DUI is an internally-managed LIC which listed on the ASX in 1991. It has a very low management expense ratio of 0.13% with the Board effectively acting as the portfolio manager. The portfolio is heavily weighted (over 70%) to Australian large cap shares. However, DUI also provides some exposure to offshore markets targeting 10-15% in international equities, gained through investment in international ETFs. There is also modest exposure to small caps at around 5% of the portfolio.
DUI is one of the best performing LICs over the 12 months to 31 July 2017 with the portfolio (pre-tax NTA plus dividends) generating a return of 10.5% versus the S&P/ASX 200 Accumulation Index return of 7.3%. The portfolio has also outperformed on a five-year basis and over the long-term, with the portfolio generating a return of 4.0% versus the benchmark index of 3.6% for the ten years to 30 June 2017. DUI was trading at a 4.5% discount to pre-tax NTA at 31 July 2017 compared to a three-year average of 6.1%. However, investors need to be aware that the Board makes changes to the asset allocation from time to time.
AMCIL (ASX:AMH) – a blend of large and small stocks
AMH is run by the same team that manages Australian Foundation Investment Company (ASX: AFI), but has less of a focus on large caps than AFI. AMH invests in companies of all sizes with around 45% of the portfolio invested in S&P/ASX50 stocks with the remainder in mid, small and micro cap stocks. Whilst the largest sector exposure is to financials, the portfolio is significantly underweight the major banks. AMH pays one dividend each year (3.5 cents per share fully franked in FY2017) so its shares are more suited to investors looking for long-term capital growth. The portfolio significantly underperformed over the 12 months to 31 July 2017 given underweight positions in the strongly performing resources, energy and banking sectors. With AMH holding a weighting of 33% in small and micro cap stocks, performance was also impacted by the relative underperformance of these market sectors. Over the long term, the portfolio has significantly outperformed delivering a 10-year portfolio return of 7.6% versus the index return of 3.6%, although tracking error has been higher than some of its peers. At 31 July 2017, AMH was trading a slight discount to pre-tax NTA, consistent with its three-year average.
Peter Rae is Supervisory Analyst at Independent Investment Research.