Summary: Since the July 2020 ban on selling commissions, over 34 ASX Closed End Funds (CEFs) have been delisted. Several more are on-route. Only 5 have launched, and all quickly spiralled into discounts with no demand.
When the financial services industry is chasing or milking the captive capital, you only hear supposed positives of LICs and LITs: better performance via no forced selling, listed daily liquidity, reasonable costs, and quality, fair managers.
But just as you sometimes can figure out the grim reality when employees quit but give exit interviews, so too do some fund managers make revealing comments when finally giving up on Closed End Funds. In this post, I will keep track of these quotes from the managers of failed ASX CEFs, and clarify the current reality and implications.
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| As managers are forced out of ASX CEFs, some hard truths become evident |
Details:
1. Forager Australian Shares Fund (FOR)
Steve Johnson's Forager Australian Shares Fund was an unlisted Open End Fund until Dec 2016. Investors could enter or exit at NAV each week. Steve detailed the reasons for converting to a Closed End Fund, with the primary reason being better performance via not being a forced seller:
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| Fixing the Future of the Forager Australian Shares Fund |
However, as a Closed End Fund, FOR (Forager Australian Shares Fund) performed abysmally. Inclusive of the 8% jump after the announcement to move back to an Open End fund, FOR delivered a Total Shareholder Return of only 1.56% annualised since 31 Dec 2016 versus 7.78% for VAS:
In the ASX announcement, Forager made the following comments about the CEF structure:
The use of the word apathy, indicates Forager sees a lack of interest and enthusiasm for ASX Closed End Funds, even when at sizeable discounts. Yet, Forager also claims that the Closed End Fund structure served the fund and investors well:
Given it's pitiful Total Shareholder Return (TSR) of 1.56% annualised since 31 Dec 2016, one can only imagine how bad Forager thinks its TSR would have been without the Closed End Fund structure protecting it from forced selling in "dysfunctional markets." And what are "dysfunctional markets" anyway? It sounds like either an opportunity to capitalise on inefficiency, or a situation you should avoid if not capable of capitalising on. Given FOR's TSR over almost 7 years, we can only conclude that they failed on this count.
In an interview with the AFR, Steve Johnson expanded on his view that Closed End Funds (especially smaller ones) are plagued with permanent, significant discounts, and investor interest isn't coming back:
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| Johnson pulls Forager’s listed strategy from ASX |
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| Johnson pulls Forager’s listed strategy from ASX |
Contrary to the assertions of CEF boosters that discounts are opportunities and often swing back providing additional returns, Steve Johnson argues that signficant CEF discounts become self-perpetuating. In his view, the discounts themselves make CEFs unattractive.
2. Are ASX CEF discounts entrenched and typically getting worse?
The below Bell Potter extract shows discounts for CEFs investing in ASX stocks. (For those reporting Monthly, NTAs are as of 30 Aug 2023. For those reporting Weekly, NTAs are as of 29 Sep 2023).
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| Bell Potter LIC Weekly Report - 6 Oct 2023 |
Some notable examples:
Code / Discount / 5yr Ave / 5yr Low
FOR: -18.9% / -10.3% / -20.1%
FSI: -21.9% / -13.3% / -25.9%
TOP: -32.5% / -23.1% / -32.7%
RYD: -18.8% / -12.3% / -22.4%
TEK: -45.9% / -21.9% / -40.4%
WAA: -15.2% / -0.4% / -19.8%
NSC: -15.6% / -16.1% / -37.5%
FGX: -13.3% / -7.4% / -17.3%
Some lessons:
(a) There is no maximum discount downside. 20% ("buying a dollar for 80 cents") is not some ultra-cheap extreme. Many ASX CEFs have spiralled well past 20%; some trade at 50% discounts!
(b) Almost all current discounts are lower than their 5yr average. Most of the few trading at premiums (WAM, WAX) have compressed massively.
(c) Most CEFs are trading much closer to the 5yr Low than 5yr High. The discount trend is clear.
(d) A few CEFs bucked the trend: BKI, PIC, WLE and PL8. See the NTA performance table below. I have written about PL8's irrational premium here. BKI has performed decently over 3yrs, though not longer. WLE and PIC have good 3yr performance and the best 5yr performance. Indeed the 5yr performance of most of the other CEFs demonstrates how high Total Expense Ratios drive most to significant underperformance of cheap, index funds (e.g. VAS, A200):
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Which brings us back to the Forager Australian Shares Fund (FOR). Did its discount occur due to being too small at $120 million and having low liquidity, and then perpetuate itself? Or was the actual driver performance?
The above NTA Return table shows that FOR only delivered 2.7% annualised in the last 5yrs! And Sharesight analysis shows it delivered only 3.41% annualised in nearly 7 years since 30 Dec 2016!
CaptiveCapital's core argument is that almost no actively-managed funds have sustained, alpha-driven outperformance after expenses. And the exception funds and temporary periods aren't identifiable in advance. The key weakness of CEFs is that they require a continuing reason for sufficient buyers to be attracted to them. So once their underperformance of cheap, index funds becomes obvious, discounts are inevitable and will only grow.
Forager is actually one of the fairest ASX CEFs and has treated its shareholders with respect. In converting to a CEF, Forager flagged the things it needed to do to avoid a discount: keep the Total Expense Ratio low (FOR's was 1.5% in 2022-23, performance fees weren't applicable), provide consistent communication, put investor's interests first, and performance needs to be good. Unfortunately, its only major failure (performance after all expenses) is the most important factor!
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| Fixing the Future of the Forager Australian Shares Fund |
3. Monash Absolute Investment Company (MA1)
MA1 listed as a LIC in 2016 and delisted in 2021 after it traded at intractable 20%+ discounts which didn't improve even after periods of better performance. Its managers - Simon Shields and Shane Fitzgerald - were among the most candid in their exit interviews about the Closed End structure and LIC deficiencies:
Monash has tried everything to get rid of the discount - an off market buyback, on market buyback, options issues, increased communication with investors and planners about the LIC and its investment portfolio performance - but hasn’t been able to shake it. They’ve also found the discount is detached from the investment portfolio’s performance, which has been good. “We are very unhappy about that,” Shields, the former head of equities at UBS GAM and CFS and one of the most senior fundies in Australia, told Street Talk. “To see people be forced to take a discount when they need to sell for whatever reason, is no good at all.”> AFR: Monash Investors done with LIC, lingering discount
“There are lots of characteristics of LICs that were not obvious to us at the time such as tax and franking credit rules and they were hard to explain to clients,” he said. “We thought we understood them but we didn’t, we wouldn’t choose a LIC if we were setting it up now. “ETMFs are a better structure, has more protection and passes on income. ETMFs are designed for investors whereas LICs are designed for businesses.”
The LIC industry body LICAT was forced to jump into to defend LICs and inadvertently confirmed all of their pitfalls, admitting that they were:
- "unsuitable for investors who were looking to withdraw their capital easily."
- unsuitable for "investment managers without a steady pool of long-term clients." (i.e. new suckers to replace the disillusioned ones trapped inside)
- unsuitable for fund types (e.g. concentrated, long-short) which the "investing public have limited familiarity."
- unsuitable for managers who can't control the "ongoing mismatch between the volume of the patient and willing buyers of their shares and the volume of existing investors seeking to sell."
See: > Money Management: LICAT hits back at Monash criticism
With this kind of defence, I'd love to see LICAT discuss Closed End fund suitability till the cow's come home. Maybe they'd end up ticking off the dozens of CEF deficiencies I list here?!
4. Partners Group Global Income Fund (PGG)
To be continued...
Next up, PGG which is converting to an Open End Fund.
The key element I will be focusing on for PGG is whether it sufficiently addressed the CEF issue of having a continuing reason to attract sufficient buyers to maintain a balanced market between buyers and sellers.
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