Monthly Listed Investment Company Report – Sep 2019

This story features MOGUL GAMES GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: MGG

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A Listed Investment Company (LIC) is a listed investment vehicle that offers investors access to a diversified portfolio of shares in other companies also listed on the stock market. (Also known as listed investment trust.)

Note: For comprehensive comparative data tables for LICs and ETFs please see attached.

Magellan Launches New Listed Investment Trust

Following the successful listing of the Magellan Global Trust ((MGG)) in October 2017, fund manager Magellan Financial Group ((MFG)) has decided to launch another listed investment trust. The offer for the Magellan High Conviction Trust (proposed ASX Code: MHH) is currently open and is expected to close 27 September 2019.

MHH is seeking to raise a minimum of $250m with no stated upper limit. The offer is unique in that Magellan will not be paying any “stamping fee” or other sales fee to brokers or advisors as part of the raising. In essence these fees will be going direct to investors with investors in the trust receiving loyalty units (up to 7.5% for priority investors in certain Magellan vehicles and 2.5% for applications under the wholesale and general offers).

Magellan is paying all costs of the offer, including the cost of the loyalty units. It has become the norm for investment managers to pay upfront listing costs such that net asset value on day one is equivalent to the amount subscribed by investors. With such a large, loyal investor base, it is relatively easy for Magellan to distribute product to existing investors without paying third parties for distribution. However, small players and new entrants to the market, particularly overseas managers without an established presence in Australia, do not necessarily have this luxury.

Magellan has been running its high conviction strategy since 2013 and the unlisted fund, Magellan High Conviction Fund, has generated net returns of 16.6% p.a. since inception in July 2013 (excess returns of 2.3% p.a versus the MSCI World NTR Index) and has consistently generated alpha over a rolling 3-year period. The fund has performed particularly well in down markets.

The new trust, MHH, will replicate the Magellan High Conviction Fund (MHCF), and will be based on a very high conviction, concentrated, ‘best ideas’ global equities and benchmark agnostic mandate. The portfolio will hold 8 to 12 of the Manager’s best global stock ideas based on the same investment process that underpins the long running Magellan Global Fund (MGF) and the Magellan Global Trust (MGG). It will be managed by the same investment team, portfolio manager and according to the same investment methodology as these two investment vehicles. The Trust will target a cash distribution yield of 3% p.a. which is to be paid semi-annually. Currency exposure will be actively managed.

The offer structure creates a strong alignment with investors’ interests but fees are high for a large cap mandate. However, we do note the ‘payback’ investors receive through MFG bearing all establishment and listing costs, underwriting the priority offer and funding the ongoing 5% discount DRP.

Our rating for MHH is Recommended. However, we remind investors that the Trust is an extremely concentrated global equities mandate that historically, by way of MHCF, has been materially overweight to technology stocks. The Manager readily acknowledges the Trust is not suitable for all investors given its potentially high inherent risk profile, notwithstanding an investment philosophy that focuses on high quality companies with sustainable competitive advantages and predictable earnings. Also, investors in existing Magellan global funds need to understand that investing in MHH will lead to increased exposure to some stocks. For more details refer to our full report

VGI Asian LIC Offer Opens

Last month we wrote about VGI Partners plans to launch a new Asian focused LIC, VGI Partners Asian Investments Limited ((VG8)). The offer is due to open on 23 September and close on 22 October 2019. VG8 is seeking to raise between $250m and $800m with the ability to raise an additional $200m in oversubscriptions. It has already secured $200m under the conerstone component of the offer. The Manager will absorb the costs of the listing such that the NTA at listing will be the same as the issue price.

Similar to VGI Partners Global Investments Limited ((VG1)), the Company will offer investors exposure to an actively managed long-short portfolio of international equities that is benchmark agnostic, but specifically targeting selective Asian markets. Geographically, the focus will be on companies listed in countries with a robust and reliable legal system, strong corporate governance and developed capital markets.

In practice this means that, for several years at least, the portfolio will be heavily weighted towards investments in Japan, South Korea, Singapore, Hong Kong, Taiwan and Australia. The portfolio is expected to comprise 15-30 long positions, 5 to 25 opportunistic short positions and generally a substantial cash holding, with a gross exposure of typically 70% to 120%.

The strategy is based on a philosophy of providing superior long-term growth through a concentrated portfolio with a strong bias to capital preservation. The investment philosophy and process will be the same as that employed by VGI Partners for the last 11 years and will be managed by the existing VGI Partners investment team. The Company has a long term target net return of 10-15% p.a.

We have undertaken research on VG8 and our rating for the company is Recommended. The Manager has a long-term investment horizon for its long positions and, given the portfolio will have a material long bias, it is suited to those who are looking for a long-term investment with exposure to Asian markets.

VG8 will pay a dividend at the board’s discretion, however, will be focused on capital returns and therefore its is not suitable for investors seeking a regular income stream. VG8 is a high conviction, differentiated and benchmark unaware mandate. We expect returns to be fundamentally different to the broader Asian markets and, by definition, a function of Manager skill. Asian markets typically exhibit relatively high volatility. Refer to our full report on VG8 for more details.

Plato LIC Raises Additional Capital

Plato Income Maximiser has completed a capital raising of $144.2m via a 1 for 1.6 entitlement offer broker firm shortfall offer. This was short of the $204m maximum sought under the offer. PL8 will use the funds to grow its portfolio of Australian listed equities, predominantly large cap dividend paying shares. PL8 will have a market cap of around $480m after the issue of the new shares.

PL8 aims to provide investors with a stable, fully franked dividend, and in FY2019 paid regular monthly dividends of 0.5 cents per share equating to a 5.5% dividend yield (based on the offer price of $1.10 per share). Additionally, PL8 paid a special dividend of 3.0cents per share in FY2019. Our rating for PL8 is Recommended Plus.

LIC Takeovers Near Completion

The takeovers of Mercantile Investment Company ((MVT)) by Sandon Capital Investments ((SNC)) and CBG Capital ((CBC)) by Clime Capital ((CAM)) are all but done and dusted with both achieving more than 90% acceptances meaning they can proceed to compulsory acquisition.

We view the takeovers as a positive for all sets of shareholders given they will own shares in larger LICs which will hopefully have more relevance in the market, greater liquidity and lower combined costs spread over a larger asset base.

With a significant number of LICs trading at discounts to NTA we continue to expect further consolidation in the sector and other forms of corporate action designed to address both the issue of scale and persistent discounts to NTA.

Qualitas Real Estate Income Fund to Raise Additional Funds

Listed investment trust, Qualitas Real Estate Income Fund ((QRI)), has announced a 1 for 1 entitlement offer at an issue price of $1.60 per unit to raise up to $266m. The offer price is in line with the net asset value (NAV) at 31 August 2019.

QRI, which invests in a portfolio of commercial real estate loans, listed on the ASX in November last year after raising $231.2m via an initial public offer. It subsequently raised another $34.7m via a placement in June 2019. The IPO and placement funds are now largely invested or allocated for investment. Additional capital is now being raised given a strong pipeline of potential new investment opportunities.

QRI aims to achieve a target return of 8.0% p.a. (net of fees and expenses) and pay monthly cash distributions. Since listing the trust has paid 4.73 cents per unit in distributions.

Our rating for QRI is Recommended, however we are undertaking research on the capital raising and will be preparing a special report on the offer.

Managing Discounts and Premiums

Over the course of the last 12 months we have seen discounts to NTA on the whole widen in our LMI coverage universe and where they existed premiums have narrowed or turned into discounts. Even LICs which have seen their shares trade at 20%+ premiums to NTA over the past few years, such as WAM Research Limited ((WAX)) and WAM Capital Limited ((WAM)) have seen their premiums to NTA contract to the smallest levels in many years.

This waxing and waning of premiums and discounts has been part and parcel of LIC investing for many years. This can provide opportunities for investors but also make it difficult for investors to gain access to quality LICs trading at premiums. We note that WAX and WAM, have traded at persistent premiums for many years and those looking to buy into the shares at NTA, or even a discount, have been left in waiting.

Similarly, there are other names that have traded at persistent discounts for many years with no end in sight despite, in some cases, solid underlying portfolio performance. The existence of these persistent discounts has lead to corporate activity in the LMI sector with takeovers and mergers and more recently the windup of LIC’s such as 8IP Emerging Companies ((8EC)). We have also seen the announced restructure from a LIC to an active ETF vehicle in the case of Monash Absolute Investment Company ((MA1)).

Despite the launch of on market and off market buybacks to try and control and narrow persistent discounts we have not yet seen the introduction of explicit discount control mechanisms in the Australian market. These mechanisms are relatively common place in the UK Investment Trust (IT) space which is equivalent to the listed investment company space here in Australia.

A standard example would be that when a company’s share trades at for example a greater than 10% discount to its NTA this immediately triggers an on market buyback by the company. Similarly if the shares trade at a great than 10% premium to its NTA the company would issue shares into the market at NTA.

The logic behind this strategy is that as the discount control mechanism is clearly articulated it helps to keep the share price trading around its NTA as there is a clearly defined mechanism and course of action to be followed in case the share price moves well above or below the NTA. The band around which the share price can deviate from the NTA before the mechanisms are activated are set by the board and can be as tight or as loose as deemed fit given the underlying assets in the company.

While discount control mechanism are not the panacea for persistent premiums and discounts, evidence from the UK market would suggest they can help alleviate such large divergences from NTA and allow investors to trade in and out closer to NTA the majority of the time.

We note that many Australian LMIs do have the ability to use buybacks as part of their capital management and a number of LMIs have buybacks currently in operation. Despite this many continue to trade at large discounts to NTA with the buybacks being ineffective in reducing the discount. Continued buyback of securities will also lead to reduction in fund size and is unlikely to be of any real benefit to LMIs that are already subscale.

With regards to managing premiums, we note that some LMIs, such as WAM, have actually used their premiums in the past to issue new securities above NTA and hence lift NTA per share.

With AGM season fast approaching for the vast majority of LIC’s in October and November, the issue of persistent discounts, along with potential strategies for addressing the discounts, is something that LIC shareholders can raise with Boards at the AGM. We continue to expect further consolidation in the sector and other forms of corporate action designed to address both the issue of scale and persistent discounts.

Spotlight on Westoz Investment Company

Westoz Investment Company ((WIC)) is a Perth-based LIC that listed on the ASX in September 2009. Its objective is to generate a positive return over the medium to long-term, regardless of movements of the broader share market, from an actively managed portfolio of small to mid cap ASX listed investments and provide shareholders with a consistent stream of dividends.

Stocks selected within the portfolio are generally outside the top 100 and will typically have a connection to Western Australia whether it be through their assets, operations and/or management. The Company’s portfolio is managed by Westoz Funds Management Pty Ltd, a 100% owned subsidiary of Euroz Limited. Euroz is invested alongside WIC shareholders via a 27% shareholding.

WIC has a concentrated portfolio with the Manager taking high conviction positions in ASX-listed stocks. The Manager will hold cash in the event attractive opportunities are not available. Due to its investment philosophy and geographic focus WIC invests primarily in ex-50 stocks and, as such, an investment in WIC incorporates the risks associated with an investment in the mid and small cap universe and exposure to a narrow geographic base. Investors should bear both these factors in mind when reviewing the LIC.

Given the characteristics of WIC’s portfolio we expect it to experience greater volatility than the benchmark index which is the S&P/ASX Small Ordinaries Index. As such, prospective investors should be risk-tolerant and understand the risks associated with the small and midcap investment universe and exposure to the cyclical, resource based WA economy. Investors should also be aware that the Manager may hold significant amounts of cash, diluting the portfolio’s exposure to the market.

After some volatility, dividends have stabilised in recent years and WIC has maintained a 6.0 cps full year dividend since FY16. WIC has built up its profit reserve to be able to maintain the dividend of this level for over 5 years. This means it has the ability to maintain the dividend even if the portfolio goes through a period of weakness as was the case in this last 12 months where it under performed. WIC announced a 3.0 cps per share fully franked final dividend in August 2019 and reaffirmed its target to pay 6.0 cps for FY20.

We believe the stabilisation in the dividend has partially contributed to the general reduction in the discount to pre-tax NTA over recent years with the discount as low as 4.1% in December 2018. The discount at the end of the July 2019 was 7.1% which is below its 3 year rolling average discount of 10.8%. However, the discount has since widened and at the time of writing was 14.8%.

WIC had circa 8.6m options with a strike price of $1.06 which expired on the 31st of August 2019. Some of the options were exercised ahead of expiry as the share price has traded around and slightly above the strike price over recent months. We note however, that the vast majority of the options expired worthless.

As the options have now expired this may help the share price in the near term as it is not weighed down by constant option exercising as the share price traded in line or above the option strike price. With the options now cleared, a meaningful discount and a clear dividend policy indicating a 5.8% fully franked yield at the share price ($1.04) as at the time writing, this could be an opportune time for investors to assess WIC as an investment opportunity. We have a “Recommended” rating currently in place for WIC.

Independent Investment Research, “IIR”, is an independent investment research house based in Australia and the United States. IIR specialises in the analysis of high quality commissioned research for Brokers, Family Offices and Fund Managers. IIR distributes its research in Asia, United States and the Americas. IIR does not participate in any corporate or capital raising activity and therefore it does not have any inherent bias that may result from research that is linked to any corporate/ capital raising activity.

IIR was established in 2004 under Aegis Equities Research Group of companies to provide investment research to a select group of retail and wholesale clients. Since March 2010, IIR (the Aegis Equities business was sold to Morningstar) has operated independently from Aegis by former Aegis senior executives/shareholders to provide clients with unparalleled research that covers listed and unlisted managed investments, listed companies, structured products, and IPOs. IIR takes great pride in the quality and independence of our analysis, underpinned by high caliber staff and a transparent, proven and rigorous research methodology.

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This publication has been prepared by Independent Investment Research (Aust) Pty Limited trading as Independent Investment Research (“IIR”) (ABN 11 152 172 079), an corporate authorised representative of Australian Financial Services Licensee (AFSL no. 410381. IIR has been commissioned to prepare this independent research report (the “Report”) and will receive fees for its preparation. Each company specified in the Report (the “Participants”) has provided IIR with information about its current activities. While the information contained in this publication has been prepared with all reasonable care from sources that IIR believes are reliable, no responsibility or liability is accepted by IIR for any errors, omissions or misstatements however caused. In the event that updated or additional information is issued by the “Participants”, subsequent to this publication, IIR is under no obligation to provide further research unless commissioned to do so. Any opinions, forecasts or recommendations reflects the judgment and assumptions of IIR as at the date of publication and may change without notice. IIR and each Participant in the Report, their officers, agents and employees exclude all liability whatsoever, in negligence or otherwise, for any loss or damage relating to this document to the full extent permitted by law. This publication is not and should not be construed as, an offer to sell or the solicitation of an offer to purchase or subscribe for any investment. Any opinion contained in the Report is unsolicited general information only. Neither IIR nor the Participants are aware that any recipient intends to rely on this Report or of the manner in which a recipient intends to use it. In preparing our information, it is not possible to take into consideration the investment objectives, financial situation or particular needs of any individual recipient. Investors should obtain individual financial advice from their investment advisor to determine whether opinions or recommendations (if any) contained in this publication are appropriate to their investment objectives, financial situation or particular needs before acting on such opinions or recommendations. This report is intended for the residents of Australia. It is not intended for any person(s) who is resident of any other country. This document does not constitute an offer of services in jurisdictions where IIR or its affiliates do not have the necessary licenses. IIR and/or the Participant, their officers, employees or its related bodies corporate may, from time to time hold positions in any securities included in this Report and may buy or sell such securities or engage in other transactions involving such securities. IIR and the Participant, their directors and associates declare that from time to time they may hold interests in and/or earn brokerage, fees or other benefits from the securities mentioned in this publication.

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