The terms ‘discount’ and ‘premium’ are often used when discussing investing in a Listed Investment Company (LIC) like AFIC.

After an extended period of record low interest rates and as we enter what is predicted to be a period of rising inflation, it’s worth exploring how AFIC is valued to help investors understand what factors they should consider when analysing LIC.

While the general concept of shares trading at a discount or premium relative to the net tangible assets of a fund is straightforward, there are other factors to keep in mind when considering an LIC, such as fund performance over time and management expenses charged by the portfolio manager.

Simply put, NTA (net tangible assets per share) is the total value of the portfolio divided by the number of shares on issue. If an LIC has a $100 portfolio and 100 shares outstanding, the NTA per share is $1. The NTA per share does not always reflect the market price of those shares however due to many reasons, some easier to analyse than others.

This helps explain trading at a discount or premium to NTA – if the share price is higher than NTA per share (say at $1.05 from the example above), the stock is trading at a premium relative to the value of the portfolio per share, and if it is lower than NTA per share (say at $0.95 from the example above), the stock is trading at a discount.

It is a conventional investment belief that shares in LICs trading at a discount to NTA represent a good buying opportunity, but it is not always as straightforward as this.

So, what are the driving forces of the premium/discounts?

Investment performance and costs

Good management and track record are important factors when we consider our investments, and we expect that many investors apply the same rigor when evaluating an LIC.

A track record of good performance combined with low fees does mean that an LIC is an attractive investment which helps drive awareness and demand for the shares. As a result, the share price will usually, over the long-term, trade in line with the NTA.

When fees are considered, some investors may be willing to pay a small premium if the managers can deliver excellent performance in relation to the lower fees over the long-term.

Dividends

Many LIC investors are looking for stable fully franked dividends as part of their investment strategy – especially for SMSF investors who can take advantage of these dividends and are looking for income in retirement. As a result, those LICs that have stable or growing fully franked dividends sometimes trade at a premium.

On the other hand, there are LICs that have more variable dividends, or no dividends at all, which can often lead to greater fluctuations between the price of shares and the NTA and can lead to a persistent discount.

Many long-standing LICs have profit and franking credit reserves that they can draw on in more difficult times. We have been able to draw on these reserves to distribute attractive dividends to our shareholders even when companies are delivering subdued dividends, as has been the case more recently. When the market is under more pressure or uncertainty prevails, AFIC has traditionally traded at a premium.

Size of the fund

Generally speaking, there can be a correlation between the size of an LIC and the long-term position of its share price relative to the NTA. Many small LICs have traded at a discount for long periods of time. This may be because of the lack of liquidity in the shares, the small shareholder base which means a reduced pool of buyers and sellers, or even general investor awareness may be limited.

With a shareholder base of over 160,000, we know that word of mouth is an important driver of demand for our shares. Because of this, periods where the share prices trades at a discount to NTA can be short-lived.

Considering AFIC

Our share price relative to NTA per share often correlates to the current state of the market, including the outlook for income across companies, the level of interest rates and investor sentiment toward risk.

For example, when the GFC hit in 2007 and dividends were being cut across the market, we quickly began trading at a premium. Investors were attracted to the more stable portfolio of quality companies and our ability to maintain dividends from our capital reserves throughout that difficult time.

This is a similar sentiment now as we emerge from the COVID-19 pandemic – again we’ve paid consistent dividends through this period, despite any change in earnings. As a result, AFIC is currently trading at a large premium to NTA.

We see more value in considering factors that contribute to the long-term performance of a LIC rather than the short-term focus on discounts and premiums. We view share price relative to NTA as something to consider when looking for the right time to buy, but certainly not the only consideration.