The Listed Investment Companies (LICs) market had a double shot of good news this month, as two better-known small-cap investment funds announced initial public offerings (IPOs).
NAOS Asset Management wants to raise up to $50 million for the NAOS Emerging Opportunities Company, and Contango Asset Management up to $200 million for the Contango Mid-Cap Income LIC, which it expects to list late in December. NAOS should list its LIC in January.
WAM Capital’s recent capital-raising success shows investors are eager for the right LIC offers. WAM lifted its placement from $25.9 million to $38.9 million after heavy oversubscriptions.
The NAOS and Contango IPOs add to the LIC sector’s renewed momentum. As Investor Weekly reported in November, the LIC market has outperformed the S&P/ASX All Ordinaries index this year. The Australian Securities Exchange (ASX) Composite LIC Index is up almost 14 per cent this year and the average sector discount to pre-tax net tangible assets (unweighted) was just minus 0.13 per cent in October.
But the LIC sector’s combined $18 billion market capitalisation in October is still down on levels two years ago and there are 10 fewer LICs. There was speculation that more LICs would de-list from the ASX because they were unable to narrow seemingly permanent discounts to their pre-tax NTAs. Now the talk is of more funds raising capital through LICs next year.
The LIC structure is especially useful for fund managers, such as NAOS, that specialise in micro-cap companies and hold them for long periods. Unlike in open-ended unit trusts, LIC managers are not forced to sell stocks to meet fund redemptions – a requirement that can crunch fund performance.
The NAOS and Contango offers are small in the overall scheme of the LIC market, and there is no guarantee of closing or raising much more than their minimum subscriptions in such a weak IPO market. Even so, IPOs from established small-cap managers will boost interest in parts of the LIC market.
NAOS, in particular, has a good record and a strong board for its size. Morningstar ranked the NAOS unlisted retail fund, the Emerging Companies Long Short Equity Fund, in the top-five equity funds in Australia over three-, five- and seven-year returns to end-September 2012. That fund tends to take bigger bets in micro-cap information technology, telecommunications or life-science companies; the NAOS LIC will be similar.
The LIC has a strong Macquarie Group connection. David Rickards, former executive director and global head of research at Macquarie Group (1989 to 2012), is chairing the NAOS LIC. Warwick Evans, former managing director of Macquarie Equities (1991-2001) is a director. His son, Sebastian Evans, is the managing director of NAOS Asset Management, the LIC’s manager.
Their involvement should ensure strong interest in the NAOS LIC. It will appeal to self-managed superannuation funds seeking listed exposure to promising small-cap companies in faster growing industries such as technology, life-sciences, and digital media and communications.
Contango has staked its claim in the mid-cap stock space. It wants to hold 30 to 40 securities outside the 30 largest ASX-listed companies, and target a minimum annual return of 7.2 per cent payable quarterly. The focus is on stocks with higher dividend yields and franking credits.
The Contango LIC will presumably look for mid-cap growth stocks that offer a combination of capital growth and dividend yield. The LIC can hold up to 50 per cent of its investment portfolio in cash and use derivatives to manage the risk of a broader sharemarket decline. The NAOS LIC can also use derivatives and its mandate allows up to 20 per cent of the portfolio to be held in unlisted securities.
The Contango LIC pays no fees to its investment manager for two years; NAOS Asset Management earns 1.25 per cent each year from the NAOS LIC. Contango’s annual fee is 1.66 per cent after two years. Both LICs have significant performance fees once they beat their hurdle rates.
Contango’s existing LIC, Contango MicroCap, has a five-year average annual total shareholder return (including dividends) of minus 6.6 per cent. The annual return is 8 per cent over three years. The LIC traded at a 16.7 per cent discount to its pre-tax NTA in October 2012, ASX data shows.
The big challenge for NAOS and Contango will be ensuring their LIC trades at a premium to NTA. Contango intends to use share buybacks when the shares fall below 90 per cent of the NTA for three consecutive calculation dates. It could take a few years for the LICs to earn the market’s support and be priced at a premium to their NTA, assuming both funds perform.
