LIC/LIT Monthly – September 2021

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Capital raising announcements over the month that may raise up to a maximum of approximately $975m and several more de-listings. Partly a portent of the way the sector will likely move, with a number of the LICs/LITs that raised capital being very much ideally suited to the closed ended structure. They have utilised that structure well, and they are ‘thriving’. It is this direction the sector will ultimately move, just as it did in the UK post that country’s abolition of stamping fees many moons ago. Namely, the progressive move to asset classes and strategies ideally suited to a close ended structure (read generally away from equities).

PGF proposes a merger with sister LIC PAF only to have WAM counter bid, utilising its premium to NTA ‘currency’. The irony is PM Capital may now be in the unenviable position to counter. The problem is if PGF counters on PAF materially in excess of the PAF NTA, which it may ultimately have to do, it will prove dilutive. In the interim, PAF shareholders may be able to sit back and enjoy (or crystallise value through) the ride.

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LIC Monthly Sept 2021

5 Myths & Unknowns about LICs

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“The LIC Sector Underperforms Unit Trust Peers”. Verdict: Impossible to Determine. “All Investors in a LIC get the Same Performance”. Verdict: False. “The Sector Trades at a Discount to NTA”. Verdict: False. And other common misconceptions.

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5 Myths & Unknowns About LICs

New Capital Raisings – a Buoyant Period

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It remained a relatively buoyant month in relation to capital raisings. In fact, there were some potentially large licks of additional capital raise announcements, notably the FGX 1 for 1 Bonus Options announcements. The sum total of the maximum amount of capital that could be raised based on announcements over the month is approximately $975m.

Of course, given the largely part of this comprises a 1 for 1 bonus option offer and two unit purchase plans, this maximum amount will not be achieved. Nevertheless, it has been a buoyant several months in respect to capital raisings on the back of some very solid performance and a general contraction in discounts to NTA (where they were present).

These capital raising developments also follow on from the Metrics Income Opportunities Trust (ASX: MOT) raising $53m in a 15% placement and issuing a Unit Purchase Plan that has the potential to raise approximately $100m.

Gryphon Capital Income Trust (ASX: GCI) returned to the market for the second time in a month (after completing a placement to wholesale and sophisticated investors equal to 15% of total issued capital) announcing a Unit Purchase Plan (UPP) on 7 September. Under the terms, existing investors can purchase up to a maximum of $30,000 in additional units at a UPP price of $2.01/unit, the same pricing as the prior 15% placement. This equates to a maximum of circa $140m in additional capital. The manager has actually erred on the conservative side in relation these two raisings (in terms of additional FUM size), and we perceive no ‘digestion’ issues with the timely investment of the additional monies given the liquidity of the RMBS market (i.e., no cash dilution risk with respect to monthly income).

On 7 September, Sandon Capital Investments Limited (ASX: SNC) announced a 1 for 4 non-renounceable entitlement offer at $1.01/share, representing a 15% discount to the pre-tax NTA as at 31 August but in-line with the share price at the same date. Note: taking up the offer will lead to dilution for such investors. The offer has the potential to raise up to $27.9m. Based dividend guidance for FY22 period, the new units are expected to earn a dividend yield of 6.4%, or 8.6% on a grossed up fully franked basis. SNC has had an exceptionally strong last 12-month period, generating total NTA returns of approximately 50% (or 71% on a total share price returns basis), and has outperformed the Australian Small-Mid Cap Peer Index median over this period. The discount to NTA has compressed gradually over this period and in this respect the additional capital raise is well timed.

On 30 August, Flagship Investments Limited (ASX: FSI) announced a redeemable, unsecured convertible note issue of up to $20m. Key terms are: offer price $2.70; interest rate of 5.5% p.a. up to 30 Sep 2024 and increasing to 6.5% thereafter if the Bank Bill Swap rate exceeds 1.2832%; maturity date of 1 Oct 2026 (if not converted or redeemed earlier). Between Feb to April 2021, the discount to NTA compressed to a near all time low of circa -5%, no doubt driven by what had been consistently solid performance relative to the peer group median. Since that time FSI has materially underperformed the peer group over the last six months, which may have led to the discount to NTA expanding again. FSI were no doubt keen to pursue alternative capital raising initiatives, and in our view, would had ‘earned’ the right to do so given its relative performance. That said, there is the potential for a convertible note issue to be NTA accretive for share holders But it can also be dilutive. This risk is two-fold: 1) if the cumulative income paid out to note holders exceeds the incremental returns generated by the capital raised, then the notes are returns dilutive (but we note the converse applies); and, 2) if the conversion price at the time of conversion is less than the NTA/share (and why else would one convert, assuming the persistence of a discount to NTA) then the conversion into ordinary shares may prove dilutionary.

On 3 September, Future Generation Australia Investment Company Limited (ASX: FGX) announced a 1 for 1 Bonus Options issue. The key terms are exercise price $1.48; expiry date 28 April 2023; ASX code FGXOA; and ASX trading commencement 5 October 2021. Given the eligibility for the upcoming dividend of 3 cps if the options are exercised on or before 17 Nov 2021, these options have been priced at-the-money which clearly maximises the potential for a maximum capital raise as well as the potential to raise that capital sooner rather than later by way of investors exercising the option. On the flip side, it also maximises NTA performance dilution risk at the headline level, which is different from at the investor level. The Bonus Options have the potential to raise an additional $582M in capital should 100% be exercised (which never happens). Nevertheless, the Bonus Options do have the potential to elevate FGX into realm of one of the large equities LICs. And what about FGX’s sister strategy, Future Generation Global Investment Company Limited (ASX: FGG)? Simple – its trading at a circa 12% discount to NTA versus the circa 4% discount of FGX. However, should the discount to NTA of FGG materially compress to levels approaching partity to NTA, it is reasonable to expect a similar development with FGG.

KKC – Further Discount to NTA Control Initiatives

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On 15 September, the KKR Credit Income Fund (ASX: KKC) provided details on its discount control initiatives for at least the next 12-month period, on which is a new development. Specifically, KKC announced the resumption of its buy-back program for the FY22 period as well as fact that it is currently sounding the market out about launching an unlisted unit trust with similar objectives to KKC. The unlisted unit trust would have the ability to buy units in KKC should there be a material discount to NTA.

Such an investment vehicle, and its use in respective to KKC, would be to what Metrics has in place with respect to MXT. We would envisage the unlisted unit trust as being a wholesale only product (‘stickier’ money) and having the ability to ‘put the gates up’ in respect to redemption requests. This latter ability is necessary in an investment vehicle that invests in private debt. We would also envisage it would hold a residual cash position (perhaps 5%) to assist in potential buying of KKC units.
Additionally, the relatively short dated maturity of the private debt holdings in the underlying KKR European Direct Lending vehicle may also assist in any required cash in which to potentially purchase KKC units should the need arise.
These initiatives following on from KKC recently moving from quarterly distributions to monthly distributions, which was also designed to partly address the discount to NTA.

RRM notes the KKC unit price moved up following this announcement, with KKC now trading at its thinnest discount to NTA (10% discount) since the March 2020 market sell-off.

As RRM has previously expressed, it is our view that buy-backs often do not have an immediate material impact on a discount to NTA. Rather, the benefit tends to be more over the medium to long term, assisting in settle a share / unit register. Additionally, a buy back provides important messaging to the market, namely that a manager is prepared to act in the interest of investors.

Cadence Capital – I’m Confused

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On 20 September, Cadence Capital Limited (ASX: CDM) issued a presentation proposing a possible hiving off a specific international investment into a separate LIC – Cadence Global. The proposed demerger would encompass moving CDM’s entire holding in the The Metals Company Inc. (NASDAQ: TMC) into the Cadence Global entity plus $15m in cash.

This development occurred after the NASDAQ listing of TMC on 10 September 2021 at an IPO price of US$10/share which, on the day after listing, valued CDM’s holding at A$85m from an initial investment of A$6m, and accounting for almost 20% of the CDM portfolio. The issue for CDM is, according to the presentation, the entire holding was in escrow for a period of either 20 days trading above US$12/share (TMC was last trading at US$5.11/share after peaking at US$12.45/share on 13 September 2021) or a period of 180 days.

However, somewhat confusingly, on 22 September CDM announced that it had divested approximately one third of its holding in TMC and which was not subject to escrow. The remaining two thirds remains subject to escrow, as per the restrictions detailed above.

The position was traded on 23 September (US time), suggesting a sale price in the vicinity of US$5.46/share (the closing price on that date). TMC closed at US$5.11/share on 24 September, which we approximate equates to a residual value for CDM of A$33m, or approximately 9.0% of the total CDM portfolio.

The partial divestment in itself, tied with the residual holding as a percentage of the total CDM portfolio, suggests the initial proposal of a demerger will not proceed. CDM would have also received considerable share holder feedback following the announcement. RRM understands the rationale for the proposal – it what was then a near 20% position of the portfolio, the TMC holding was ‘problematic’ from a portfolio diversification and downside risk perspective. Being (at least partly) escrowed, placed the CDM management between a rock and a hard place.
And this ‘rock and a hard place’ needs to be partly put in the context of CDM’s investment in Melbourne IT which ran up to a significant portion of the total portfolio only to subsequently lead to a period of material underperformance. With this in mind, investors were no doubt somewhat uncomfortable with the high portfolio position of TMC.

While the manager’s rationale was / is understandable, it is also somewhat problematic. It would create at least initially a single stock portfolio and, as evident from the sell-off in TMC post the IPO, an inherently very high risk investment vehicle, notwithstanding the intention to diversify the investment vehicle over time. On the flip side, it would allow existing CDM share holders to choose their degree of exposure to TMC.

In the interim, should CDM proceed with the proposal it will take time and there is a lot of water to pass under the bridge. If the sell-off continues, the whole portfolio exposure issue may become a moot point. Equally, TMC may rebound. Should the proposal not proceed, from current share price levels, it would appear likely that CDM is locked in to its remaining position for the full 180 days.

By our reckoning, the approximate pre-tax NTA/share of CDM based on share price moves in TMC is around the $1.24/share level, equating to a rough 9% discount to NTA. The CDM share price moved up solidly in the lead up to the TMC IPO, with the CDM discount to NTA largely being removed. It appears it was a degree of the old ‘buy the rumour, sell the fact’.

PM Capital & Wilsons

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PGF and PAF Proposed Merger

On 15 September, PM Capital Global Opportunities Fund Limited (ASX: PGF) and PM Capital Asian Opportunities Fund Limited (ASX: PAF) announced it had entered into a Scheme Implementation Deed to merge the two LICs. In effect, PAF is to be acquired by PGF, with PAF share holders receiving PGF shares.
Under the proposed terms, PAF share holders will receive an amount of PGF shares based on the NTA of PGF. The implied value offer based on the respective NTAs as at 10 September 2021 was: a 23.8% premium to PAF’s closing share price as at that date, or; a 24.3% premium to PAF’s 3-month VWAP.

Given the size disparity between the two LICs, the rationale should be relatively clear – for PAF share holders to benefit from materially greater size. In this respect, PAF share holders will benefit from:

A portfolio pre-tax NTA of $712m relative to PAF’s $67m;
Approximately 8,400 share holders versus 1,200 share holders in PAF; and Market liquidity 10x that of PAF.

And with scale comes additional benefits, namely the tendency to trade at a lesser discount to NTA. On the topic, PAF has gravitated around a -16% discount to NTA whereas PGF’s discount to NTA has compressed substantially more recently to single digit levels on the back of a very strong 12-months of performance.

And with that strong performance, PGF is now in a strong position regarding future dividends, with bolstered reserves. PGF has provided FY22 dividend guidance of 10 cps. Based on PAF’s closing price on 14 September 2021 and a consequent exchange ratio of 0.7553x, this would imply an annualised yield of 7.8%, or 11.1% p.a. grossed up. This is far in excess of PAF’s 12 month trailing yield of 1.3% during which it skipped an interim dividend.
The PAF Board Committee established to the merger has recommended the merger subject to the independent expert concluding that the merger is in the best interests of share holders. The scheme meeting date is slated for 9 December 2021.

In terms of best interests, RRM sees the benefit to PAF share holders as relatively clear based on the various points noted above. Of course, the merger will entail a material change in investment strategy, but for those investors that object to that there is the ability to sell on-market. We would note that the time line of the proposed deal does permit a degree of market timing flexibility, and which may be needed given the recent sell off in Asian equities.

From the perspective of PGF share holders, the scale difference between the two vehicles does not place an overly material impact on investment strategy. But this is more about PAF share holders than it is PGF share holders.

But wait, WAM Counter Bids for PAF yesterday.
Talk about stirring the pot. On 28 September, WAM Capital Limited (ASX: WAM) announced its intention to make a conditional off-market takeover bid for PM Capital Asian Opportunities Fund (ASX: PAF).

The WAM Capital Offer exceeds the proposed scheme of arrangement between PAF and PM Capital Global Opportunities Fund Limited (ASX: PGF) (Scheme) and represents a premium to the implied value to PAF shareholders under the Scheme. Based on the 24 September 2021 Scheme exchange ratio of 0.73471 and the PGF closing share price of $1.49 per share on 27 September 2021, the scheme provides PAF shareholders with an opportunity to exit their investment at a 0.5% discount to PAF’s 24 September 2021 pre-tax NTA.

Under the Offer, accepting PAF shareholders will receive 1 WAM Capital share for every 1.99 PAF shares they own. The Offer of 1 WAM Capital share for every 1.975 PAF shares represents a 10.6% premium to the 27 September 2021 closing share price for PAF and a 5.1% premium to the 24 September 2021 pre-tax NTA for PAF.

The reader may wonder why WAM Strategic Value (ASX: WAR) has not undertaken this. Presumably 1) because the offer does not constitute a discount to NTA; 2) it would be too large an acquisition for WAR; and 3) it would not necessarily have the roll-up premium to NTA benefits relative to being acquired by WAM.

The irony is PM Capital set a proposal in place (for good reasons) but with the counter bid, the hand has been forced.

 

LIC / LIT Yield Surplus

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It is well known that LICs, as a company structure in contrast to a trust structure (LITs, ETFs, Unlisted Unit Trusts), have a structural advantage in the ability to manage / smooth income as well attach a higher and more consistent level of franking to that income.

In short, as the analysis in this article illustrates on the basis of a comparative analysis, LICs:

  1. Pay higher and more consistent income;
  2. That income is less corelated to market cycles, both in up-markets but more importantly in down-markets;
  3. On a market cap weighted basis and which represents the volume weighted dollar of investor experience (versus a median calculation – the average across all LICs), the average level of income in the LIC sector increases but it actually marginally declines in comparable ETF sectors;
  4. Due to dividend and franking reserves, past is actually precedent to a degree with LIC income (predictability of income) whereas past provides very little guide to future trust income; and,
  5. Not forgetting Debt LITs, all eight ASX-listed debt LITs have materially outperformed their ETF cousins on an income basis.

Taking all the above into consideration, it is little wonder that particular LICs are popular amongst investors in the retirement stage in their investment lifecycle. The importance of stability of income in down-markets should not be under-estimated. It reduces the need to realise capital to make up any income shortfall, and realising capital in a significant down market creates significant sequencing risk, as any issuer of retirement products knows very well.

While the S&P/ASX 200 just had a bumper dividend reporting period, the question is how sustainable that is? Some analysts believe not very, believing it was driven by a confluence of events: slashed Capex (20-year low); record iron ore prices (since materially retraced), and; 3) catch-up from slashed FY20 dividends. Whatever the case may be, the key point: uncertainty in future dividends. Which gets us back to the stability of LIC income.

But what about the discount to NTA risk? Well, again on a market cap weighted basis (exactly how all major global market indices are calculated) and representing the volume weighted of investor dollar experience, the key LIC sector have generally and continue to trade at a premium to NTA (see analysis on page 3). It appears an investor can have both the income and capital cake.

Click Link Below:

LIC_LIC Income – A comparative analysis V3

L1, Thought it wasn’t about Income. If Regal Could Buy Back Time

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L1 just banked a mere $500m to its dividend profit reserve, the equivalent of 83.24 cents per share. Future dividends guaranteed. Gees, if Regal could have their time again, I reckon they’d go LIC over LIT (that was a lot of money for Regal to pay out).

Antipodes – when you Lose a Champion & When Metrics Loses . . .

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The next RRM LIC/LIT Monthly will delve into how good Antipodes is as a (pragmatic) Value manager. While RRM covers ETFs, the loss of APL is indeed that . . . .a loss. Not only are Antipodes the smartest guys in the room (to their detriment??), they are perennially great communicators. And that mattters!

Like all Pinnacle products, communications have been superlative from the Antipodes Boys & Girls.  . . . . . . Investors are of the general view that there is one great weakness of close end vehicles (LICs/LITs). RRM is more than well aware of the matter.

But there is another way to look at the so-called issue. Antipodes and Pinnacles’ efforts have been superlative in both attempts to address that issue. What that meant is as an investor was communications, disclosure and insight into the thinking of one of the best investment managers in the country. And Antipodes are not a beta tracker – they actually think, and they think about long term trends (Antipodes is a ‘cluster’ trend investor). Whether you are an Antipodes investor or not, its worth listening into Jacob and team – they always say it in a non-biased way.

Before we cut to the below, think about Antipodes as an excellent factor overweight neutraliser in a broader portfolio and in a world in which market cap weighted indices are more than factor heavy currently. And Antipodes will have their day.

We Break to Bring you an Important Message from an Independent Source: Metrics Credit Partners’ rather Expensive Lawyers. Minter Ellison  have ordered a Cease & Desist Order on the term ‘Metrics’ with respect to Risk Return Metrics. Apparently ‘Metrics’, owns Quant. Minters, the known expensive Attack Dogs ( and we have better attack dogs – watch this play out . .  we always win . .  Minters are a Sitting Duck) have sent one of their $XK letters.

The founder of RRM asserts that he thought risk and return metrics were integral to investment analysis since the advent of the PC and Spreadsheet. The Founder goes on to say, “I was the first analyst to review Metrics – liked them from the get go. But now, it appears they own the very basis of investment research – metrics – return, risk, path performance, etc. ARE YOU FUCKEN JOKING?????.”

The well connected owner ran it past many a experienced participant in the sector. Many an eye rolled at the aggressive debt newcomer – how easily they forget. But not the analyst . . . .

Rodney goes on to say, “the irony being that i am well versed in the private debt premia, and illiquidity is the least of the three components. i have been a strong, yet objective, advocate of the asset class. Why wouldn’t I be???? Oh, on the topic, have you seen the iPartners product? 10%, strongest collateral protections I’ve seen – benefit of Ex Deutsche ABS guys. Hands down, the best I have seen. Tell Travis Miller i sent you.”

Rodney goes on to say “if you want real private debt premia, play where the likes of Metrics and Qualitas can’t play – they are too big”. “Peeps think private debt is not capacity constrained. Well, they are thinking about capacity constraints in the wrong way. This reminds me of Winton and ads on the London Tube – dialling down risk to address FUM inflow. Do your remember??i do. And the rest is a Banal history. The things Metrics will learn”. My, the look in his eye.

Capacity constrained.” I’ll tell you about capacity constrained, Does Metrics have a nice word to say re Qualitas? no. Debt managers are bitchey – they compete on deals. Look out – KKR will enter. And you don’t want KKR in the back yard. Rodney said” listen, if KKR trade marks me, now that’d i’d be proud of”. KKR will enter the market because Metrics are losing Supply / Demand premia. Which gets me back to iPartners.

Rodney is running a Book on how Uesless Minters are. One to one – you think they will win??? Rodney says ” I prefer my attack dog”.

We Need to Talk about Magellan

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Shock, horror. The horror being the last 18-months, a period in which there was a (blind??) endeavour to repeat the downside mitigation moves Magellan made in the GFC and set its history . . .  to recent date. It was these moves that made Magellan – going into cash.

Fast forward circa 20+ years – “Don’t fight the Fed” – the memo that almost every investment manager had  read. Now, the move into cash in March-April 2020, one would well understand. Regal did the same thing. But as April 2020 rolled through, Regal (ever responsive) realised a dynamic was in play – they went aggressively long, and the rest is history.

The issue with Magellan, to cut to the chase, is an issue of a strong leader / not having a flat democratic structure. In my humble opinion. But i have reviewed many a fund manager. The very launch of a 10-12 stock portfolio (MHH), highly concentrated not only but stock, but by geography (US), Sector (tech), factor (growth) valuation metric (exceptionally high P/E), and by very high Cross-correlation between the 10-12 stocks. It was a gutsy move from day 1, not that Magellan did not recognise and state that MHH was not designed to be suitable for all investors.

Back in the day, financial advisors almost by default allocated the international equities allocation to either Platinum or Magellan. Those days are gone, and that is no bad thing.