Illustration: Karl Hilzinger.
A SHARE buyback is the only way you can legally manipulate your company’s share price and get a tax break at the same time. It is also an especially useful tool around the end of the financial year, as the likes of listed investment companies (LICs) go about their ”window dressing”: a euphemism for sprucing up their share prices. All perfectly legal, of course.
So it is that Djerriwarrh Investments, for instance, has Goldman Sachs conducting its on-market buyback program. Djerriwarrh can tell Goldman to buy 21 million shares, the full extent of the facility, whenever it likes, or any portion thereof.
Alternatively, it can just announce a buyback, as it has, and never buy a single share. Legally, it has no obligation to buy anything but the effect of the buyback announcement is nevertheless to put a floor under the stock price.
This week is a vital one for the LIC sector as share prices on the final day of the financial year can determine how much the LIC managers get paid.
Those with a penchant for deep cynicism claim that the traditional jump in some LIC prices just before June 30 is not just a magical coincidence that occurs year after year but the upshot of the LICs buying their own shares, and shares in each other for that matter.
Some of it, the share-buyback action for instance, is quite visible. But by no means all of it is visible. Buying by one LIC of shares in another LIC does not have to be revealed unless the shareholding is above the 5 per cent disclosure threshold.
An irrepressible cynic might also be fooled into thinking that the abnormally high number of bids in the market lately in, for instance, Djerriwarrh – which seemed to be the work of some party prepared to spend up big to keep prices around the $3.67 mark when Djerriwarrh’s net tangible assets (NTA) indicated a price of $3.31 – might not have all been fair dinkum bids with fair dinkum bidders behind them.
Nor should Djerriwarrh be singled out as the only worker of alchemy in the LIC market. It is one of the big ones though. And, incidentally, it suffered a mysterious 30 per cent drop in its share price last July after the close of the 2011 financial year.
The elusive chipmunks of short-term share price appreciation are at work in some LICs, and many other stocks, towards the end of reporting periods.
What is fascinating, though, is the extent of cross-buying.
There is an element of the snake eating itself in this. If one LIC takes 10 per cent of another LIC, it is effectively using its shareholders to help pay somebody else’s management fees.
But many LICs are related, managed by the same people, that is. In such cases, when there is cross-buying it could be argued that management is propping up its own management fees.
It can also be argued that, if the target LIC is trading at a big discount to NTA, the cross-buying represents good value.
The way the typical LIC works is the manager raises money in the market then spends it buying a bunch of shares. The managers keep a portion of the dividends from those shares for themselves, and pass the rest on to their investors via dividends.
Some LICS may burn through 20 per cent of collected dividends in administration and finance costs. Though LICs are mostly low-fee guzzlers these days and very few are leveraged, except Aberdeen Leaders and AFIC (with its convertible note). They are therefore a pretty safe bet.
The question is, are they a racket due to the cross-buying? No, says one of the pre-eminent managers in the sector, Wilson Asset Management’s Geoff Wilson.
”It’s a bit of a gentlemen’s club,” Wilson says. ”We buy a position and then wait for the [NTA] gap to close or for the manager to fall over.” It creates value, says Wilson, and a long-term view is required.
As for fees, Wilson points out the bigger the LIC becomes the smaller the fee is for all shareholders as the base fee is a fixed amount on funds under management.
The sector bellwethers, AFIC and Argo Investments, charge management fees of 0.12 per cent of NTA. Newer LICs charge 1.2 per cent as they are externally managed.
Taking out a rival LIC then becomes a scale exercise with little destruction of value for minorities.
The following is a response to this article by Djerriwarrh Investments:
I refer to the article published on 25 June concerning the use of share buy backs by Listed Investment Companies (LIC’s) and in particular Djerriwarrh Investments Limited.
Djerriwarrh currently has in place the facility to buy back shares on market but has not undertaken this activity for some years. Normally share buy backs are undertaken when the share price is trading at a significant discount to net asset backing and there is an apparent lack of demand for the shares in the market.
Under this scenario a share buy back can be valuable to existing shareholders and this is the context in which it is used. We certainly do not undertake such activity prior to financial year end to support the share price.
As noted in the article Djerriwarrh is trading at a significant premium to its net asset backing per share. We believe this is a result of the high fully franked dividend yield of 7% that Djerriwarrh offers through its investment strategies which involves generating additional income over and above dividend income by selling call options over part of the portfolio. The premium is not the result of buy backs.
Finally the cross shareholdings on LIC’s typically arise because another LIC sees value in buying assets they are familiar with at a discount. This can be a very effective investment strategy if the discount closes over time.
Geoff Driver
General Manager Business Development and Investor Relations
Djerriwarrh Investments
Michael West established Michael West Media in 2016 to focus on journalism of high public interest, particularly the rising power of corporations over democracy. West was formerly a journalist and editor with Fairfax newspapers, a columnist for News Corp and even, once, a stockbroker.