Listed Investment Companies (LICs) have been in vogue in recent years, with a whopping 98% increase in listings between June 2013 and March 2017. In its 2017 Listed Investment Companies Sector Review, Zenith seeks to uncover the drivers of this growth and to determine whether it is sustainable.
Zenith’s research into this growth and sustainability focused on the period between July 2004 (when LIC data was first available) and March 2017; June 2013 to March 2017 was overwhelmingly the strongest period of growth for LIC listings. There were 95 LICs listed on the ASX as at 31 March 2017, and the last 12 months produced a 10% increase in the number of listings.
Justin Tay, Senior Investment Analyst, explained the drivers of this growth: “We believe the growth and contraction in LIC listings are cyclical in nature, so we assessed whether stock market performance has played a part in the cyclicality of LIC listings.”
“Given this belief about the cyclicality of LIC listing growth, with investor and market sentiment key drivers, we expect that the current rate of growth in the sector is unlikely to be sustained over the medium to long-term.”
Market performance and the premium or discount to NTA
LICs typically trade at either a discount or premium to their net tangible assets (NTA). Zenith has observed a relationship between market sentiment and the premium/discount of LICs. That is, when there is negative market sentiment, LICs generally trade at a discount. However, the research also revealed that regardless of the sentiment towards the sector, LICs had, on average, traded at a discount to NTA up until April 2013.
“We believe this could be the result of several specific drivers,” said Tay.
“These include the rapid increase of SMSFs and amendments to the Corporations Act in 2010 that allowed dividends to be paid out based on a solvency test rather than profitability.”
As part of the 2017 review, Zenith conducted a survey across its rated LICs to determine the factors that supported a LIC to trade at a premium to its NTA. It found that fully franked sustainable dividends and high levels of shareholder engagement were equally the most important factors, followed by the underlying performance of the portfolio.
“Although these factors are highly subjective, particularly with regards to fully franked sustainable dividends and high levels of shareholder engagement, we believe these factors are the key drivers to ensure that an LIC does not trade below its NTA,” said Tay.
A closer look at dividend sustainability
Zenith believes dividend sustainability is highly topical as there have been recent instances where some LICs have been required to cut their dividends. Given the importance of dividends for LICs, such cuts are highly undesirable.
“Zenith believes the dividend coverage ratio can be an indicator of a LIC’s dividend sustainability,” said Tay.
“Ideally, a LIC should have at least two years’ worth of profit reserves to maintain current dividend payments in the event there is a downturn in the LIC’s profitability.”
“Our analysis found that most LICs on Zenith’s Approved Products List maintain adequate profit reserves to sustain a growing stream of dividends, and have profit reserves that ensure dividend payments are sustainable and in accordance with dividend objectives,” Tay concluded.
Summary of the Zenith 2017 Listed Investment Companies Sector Review
From an initial universe of 76 products:
- 2 were rated “Highly Recommended”
- 11 were rated “Recommended”
- 3 were rated “Approved”
- 59 were “Not Rated”
- 1 was rated “Redeem”