Generating income and growth from PM Capital Listed Investment Companies

PM Capital Global Opportunities Fund Limited – investment performance delivering growth in Net Tangible Assets and fully franked dividends.

Since its November 2013 Initial Public Offering, the PM Capital Global Opportunities Fund Ltd (ASX: PGF) has aimed to generate attractive long term returns by gaining exposure to a greater investment opportunity set than exists in Australia.

Those returns are delivered to shareholders through long term capital growth in Net Tangible Assets (NTA) per share and a steadily growing stream of fully franked dividends.

I’m pleased to report that PGF’s underlying portfolio is delivering on long term capital growth: the portfolio returned 54% in the financial year to June 30, 2021.¹

Since inception to the end of Financial Year 2021, PGF’s total underlying portfolio return is 156.9%.²

This attractive portfolio return is, in part, reflected in PGF’s rising NTA per share. On 20 August 2021, PGF’s pre-tax NTA was $1.66 per share.³ Whereas, on 21 August 2020, it was $1.17.⁴

As a closed-ended fund, Listed Investment Companies can trade at a discount or premium to their NTA. At 24 August 2021, PGF traded between its pre-tax and post-tax NTAs. 

As such, PGF traded at a 4.0% premium to post-tax NTA and a 6.0% discount to its pre-tax NTA, ASX data⁵ shows. 

In theory, this means zero-rate taxpayers, such as Self-Managed Super Funds in pension phase, could buy $1 worth of PGF assets for 94 cents6. 

Like many Listed Investment Companies, PGF’s current share price, relative to NTA, represents a material improvement from its Covid-impacted mid-2020 levels, when significant discounts prevailed across the LIC sector.

Taken together, PGF’s strong underlying investment performance has led to an increase in its NTA and ability to pay dividends, and largely removed the gap between its share price and NTA.

PGF upgrades dividend guidance

PGF’s underlying portfolio return has set it up for a period of higher expected future dividends.

On 12 August 2021⁷, PGF’s board announced its intention to maintain a minimum interim dividend of 5 cents and a final dividend of 5 cents in FY22 – for a minimum 10-cent annualised fully franked dividend. 

This was a 25% increase in PGF’s dividend over the guidance it provided on 12 May 2021⁸.

With retained earnings of 54 cents a share⁹, PGF reported it had more than five years of retained earnings dividend coverage¹⁰ (based on a 10-cent annualised dividend).

Using PGF’s recent share price of $1.56¹¹, the dividend guidance implies an annualised dividend yield of 6.4% – or 9.2%¹² per annum after grossed-up for franking credits. 

For context, PGF’s implied grossed-up dividend yield of 9.2%¹³ compares to the Reserve Bank’s cash target rate of 0.1%¹⁴ and bank term deposit rates of 0.25%.¹⁵

Managing income risk

Anecdotally, investors – especially those in pension phase – have had to take extra risk in the sharemarket to achieve a higher income return to live on, amid near-zero interest rates.

One option to diversify this risk is investing in an LIC, such as PGF, which has an underlying portfolio that the investment manager believes consists of high-quality companies trading at a discount to their fundamental valuations, which should return to fair value over time. 

As the investment manager realises these investments, PGF is expected to add to its profit reserve, pay tax and therefore generate franking credits - and thus be in a position to continue paying attractive, stable fully franked dividends. 

In addition, PGF’s substantial retained earnings balance has the potential to act as a buffer against unwanted reductions in dividends should short term adverse movements in share prices impact PGF’s underlying share portfolio.

Share Purchase Plan

In August, PGF offered eligible shareholders in Australia and New Zealand the opportunity to participate in the PGF Share Purchase Plan (SPP). The SPP invites applications for up to $30,000 worth of shares per shareholder.¹⁶

Shareholders who participate in the SPP (and continue to hold their shares at the final dividend record date) will be entitled to the 5 cents per share fully franked final dividend (which will be paid on 14 October 2021).

I encourage you to read PGF’s company announcements to ASX on 12 August 2021. They explain PGF’s latest dividend guidance and the SSP in detail. 

Investors in PGF’s SPP can gain exposure to its implied 9.2% grossed-up yield and future dividend stream, at a discount to the lesser of: 

•    the five-day Volume Weighted Average Share Price preceding the announcement on 12 August 2021; 
•    or the post-tax NTA on 7 September (calculated in the same way as the PGF’s weekly NTA announcements).¹⁷

Why use an LIC for dividends?

The Listed Investment Company (LIC) structure suits PM Capital’s investment style (PM Capital is the manager of PGF). LICs are mostly designed for long-term investing, something PM Capital is known for. It believes investment cycles take seven to ten years to play out fully.

 
PM Capital’s strategy is to deliver attractive long term returns by investing in high-quality companies when they trade at bottom-quartile valuations. And by having the discipline and patience to sell companies when they reach top-quartile valuations. That takes time. 

As a closed-ended fund, LICs have a fixed pool of capital to invest (which changes with capital raisings). Investors buy and sell shares in the LIC, not units in an underlying fund. This means the LIC manager does not have to consider fund inflows and outflows when investing.

The company structure of a LIC is another feature. Unlike a trust, a LIC does not have to pay out all its annual taxable income to investors as trust distributions. Because it’s a company, a LIC can retain earnings and draw on its retained earnings to pay dividends – thus smoothing future dividend payments.

As the LIC earns profits and pays corporate tax in Australia, it can generate and replenish its franking credits, enabling higher consistency in fully franked dividends. That is PGF’s expectation if it meets its goals.¹⁸

This is an attraction for Australian investors who might otherwise avoid exposure to global equities because they prefer fully franked dividends from Australian companies. 

Why invest in global equities for dividends?

To be clear, PM Capital’s style is to deliver attractive returns through capital growth. We do not invest solely for income or believe investors should view dividends as a fixed-interest proxy. LIC dividends can and do vary.

But since PM Capital’s inception in 1998, we have watched some of our investments deliver periods of strong dividend growth. By investing in undervalued shares near the start of investment cycles, PM Capital benefits as recovering growth in company earnings translates to higher dividends. 

We expect some investments in PGF to deliver high single-digit dividend yields in 2021-22.

PM Capital’s investment in European banks – one of the largest holdings in PGF – is an example. 

PM Capital expects European banks to begin a substantial dividend recovery this year as the European Central Bank is lifting restrictions on bank dividends from 30 September 2021. That paves the way for European banks to declare dividends starting in the fourth quarter of 2021.

Dutch bank ING Groep NV (a PGF portfolio holding) is trading on a double-digit forward dividend yield at its current price. 
PM Capital believes it can access a growing dividend stream from European banks that are more attractively valued compared to Australian banks. As European bank dividends rise in coming years, we expect more investors will buy those stocks, driving valuations higher.

Another key holding in PGF’s underlying portfolio – Royal Dutch Shell – in June 2021 increased its second-quarter 2021 interim dividend by 38% to US24 cents and launched a US$2 billion share buyback program. The size of the dividend increase surpassed market expectation.¹⁹ 

Conclusion 

The PM Capital Global Opportunities Fund Ltd (PGF) prospectus in November 2013 had an important insight about PM Capital’s investment style.

The PGF Prospectus said²⁰: “The nature of the Manager’s approach means its portfolios may exhibit some short term volatility … this is due to the Manager’s willingness to look through any short term risk issues and concentrate on the long term value of companies in which it invests.”

The Prospectus added²¹: “You should consider any investment in (PGF) as a long-term proposition (at least seven years).”

It’s pleasing that in 2020-21 – a little over seven years after PGF listed on ASX – PGF is delivering on its goals: rising NTA and, now, rising fully franked dividends.
 

More information on the PM Capital Global Opportunities Fund Ltd is available here.

1. Performance to 30 June 2021 after all fees and expenses, adjusted for capital flows including those associated with the payment of dividends and tax, share issuance as a result of option exercise and the dividend reinvestment plan.

2. ibid
3. PM Capital Global Opportunities Fund Ltd. Net Tangible Asset Backing – 20 August 2021. ASX Company Announcement. 
4. PM Capital Global Opportunities Fund Ltd. Net Tangible Asset Backing – 21 August 2020. ASX Company Announcement.
5. Australian Securities Exchange. Closing share price on 24 August 2021 of $1.56.
6. Based on the 6.0% discount to pre-tax NTA at 24 August 2021. 
7. PM Capital Global Opportunities Fund Ltd. “Dividend Guidance”. 12 August 2021. ASX Company Announcement.
8. PM Capital Global Opportunities Fund Ltd. “Dividend Guidance”. 12 May 2021. ASX Company Announcement.
9. At June 30, 2021.
10. Based on 54 cents per share of retained earnings at 30 June 2021
11. At 24 August 2021
12. Grossed-up dividend yield is based on a franking credit and tax rate of 30%.
13. At the $1.56 share price 
14. At 25 August 2021.
15. Based on one-year term deposit of $100,000. Source: RBA. July 2021
16. The SPP is open to Australian and New Zealand shareholders of fully paid ordinary shares in PGF at 7.00pm on the record date of 11 August 2021.
17. PM Capital Global Opportunities Fund Ltd. SPP Booklet. 12 August 2021. ASX Company Announcement
18. As outlined in its 12 August 2021 ASX Company Announcement.
19. Reuters, “Shell boosts dividend and launches buyback as profit soars,’ July 30, 2021.
20. PM Capital Global Opportunities (PGF) prospectus. November 2013. P2.
21. ibid