This article is part of the LIC Review series which covers all the conservatively managed Listed Investment Companies (LICs) on the ASX. Other LICs covered in the series include:
- Australian Foundation Investment Company Limited (ASX: AFI)
- Argo Investments Limited (ASX: ARG)
- Milton Corporation Limited (ASX: MLT)
- BKI Investment Company Limited (ASX: BKI)
- Australian United Investment Company Limited (ASX: AUI)
- Diversified United Investment Limited (ASX: DUI)
- Whitefield Limited (ASX: WHF)
I will, in time, write a review on all of these companies.
Australian United Investment Company Limited (ASX: AUI) was listed on the ASX in 1974. The company was originally founded by the late Sir Ian Potter in 1953. AUI is the sister company of Diversified United Investment Company (ASX: DUI). Similar to DUI, AUI aims to invest in a diversified portfolio of Australian equities for the medium to long term and has a very lean operating model. They focus on companies who have the potential to provide a growing stream of income and capital appreciation. Like DUI, AUI is relatively unknown to most LIC investors compared to its more famous peers AFIC and Argo. Despite this, AUI has a very impressive dividend history. AUI only invests in Australian equities which is the major difference between AUI and DUI.
Like DUI, AUI is a quiet achiever of the ASX. It’s capital appreciation and dividend payment history are one of the best on the ASX so I am surprised that it does not get as much press as AFIC or Argo. AUI is affiliated with the Ian Potter Foundation, who is AUI’s major shareholder with 41.79% of shares outstanding. This is probably one of the major reasons why AUI is not as well known. Due to the Potter Foundation’s large shareholding AUI is not as liquid as many of its peers so many large funds have difficulty buying a sizable stake in the business. This can be a good thing for smaller investors though since AUI regularly trades at a discount to Net Tangible Assets (NTA) due to this obscurity and lack of liquidity.
The Ian Potter Foundation is one of the largest philanthropic organisations in Australia. Ian Potter, a financier and businessman founded the organisation in 1964. He passed away in 1994 leaving most of his considerable estate to the Ian Potter Foundation, including his shares in DUI and AUI. AUI’s current Chairman, Charles Goode, worked at Ian Potter’s securities firm, Potter Partners. Goode was Senior Partner from 1980. Goode became Chairman and Chief Executive of Potter Partners Group Ltd in 1986 after Potter Partners became a corporation. Since the Ian Potter Foundation relies on dividends to fund its grants, it is unlikely that AUI will change it’s investment strategy any time soon. This is good since LIC’s changing their investment strategy is a key risk for long term investors.
Like DUI, AUI uses leverage to enhance returns. This is highly unusual for a conservative listed investment company such as AUI, but leverage is kept within conservative limits. As at August 2019, AUI had a bank borrowing facility of $150 million, drawn to $100 million. This means that the portfolio gearing is 7.5%. The loan has fixed and floating components and expires at varying dates through to 31 July 2023. As part of the loan agreement, AUI must pledge at least $380 million worth of securities as collateral. The current value of pledged collateral is $427 million. As at the end of FY19, cash and cash equivalents were $96 million equivalent to 7.2% of AUI’s portfolio and the interest expense was covered 13.5 times by investment revenue. AUI paid $4.8 million in interest expenses in 2019 compared to receiving $65.5 million in dividend income so AUI is unlikely to default on its debt’s anytime soon. Another important liability to consider is AUI’s deferred tax liability of $182.4 million. This relates to the expected tax which would arise when the investments are sold.
Operating expenses excluding interest amounted to 0.10% of the average market value of AUI’s portfolio in 2019. According to ETFWatch, AUI’s management expense ratio is 0.13% which is comparable to the Vanguard Australian Shares Index (ASX: VAS) whose management expense ratio is 0.10%.
As at 30 June 2019, AUI’s portfolio had a market value of $1,325,504,000. AUI concentrates on investing in large-cap dividend paying companies who have good prospects for capital and dividend growth over the medium to long term. AUI outsources their investments in small cap companies to managed funds. This is because AUI only has four people who make their investment decisions. AUI states in their Annual Report that:
“The Company’s objective is to take a medium to long term view and to invest in a diversified portfolio of listed Australian equities which have the potential to provide income and capital appreciation over the longer term. Modest exposure to the Australian equities Small Cap sector is achieved through investment in unlisted managed funds.”
AUI’s portfolio is quite concentrated compared to its other LIC peers with the top 25 investments accounting for 84% of the portfolio. This compares to the top 25 companies in the ASX 200 accounting for just 63% of the index.
As one would expect from a large cap LIC, the big four banks make up a large part of the portfolio, with an overweight position in ANZ and underweight position in NAB. There is also a noticeable overweight position in Transurban Group. Since I made the below graph AUI has increased its exposure to CSL making it AUI’s second largest investment behind Commonwealth Bank.
Compared to its peers, AUI is the second most exposed to the Big Four banks and is the most overweight in BHP and Rio Tinto. This reflects AUI’s concentrated portfolio.
AUI has four directors and just one employee: their company secretary. The Board is in charge of all investment decisions. AUI has just four directors: Charles Goode (Chairman), James Craig, Fred Grimwade and Dion Hershan. All four of these directors have extensive investment and business experience. These directors make all investment decisions for the company thus it is important to delve into their background to make sure they know what they are doing.
Charles Goode is Chairman of sister company Diversified United Investment, is former chairman of ANZ (1991 – 2010) and is a former director and Chairman of Woodside Petroleum. Goode retired from Woodside in 2007 after 19 years as director and 8 years as Chairman. Goode is also a Governor and Chairman of the Ian Potter Foundation and a director of Flagstaff Partners, a corporate advisory firm. Goode has also been Chairman of DUI since 1991 and AUI since 1990.
James Craig is Chair of the investment committee of Australian Super and two investment companies: River Capital Pty Ltd and IP Generations Pty Ltd. He is also Chairman of AUI’s Nomination and Remuneration Committee and has been a director since 2009.
Fred Grimwade is a Principal and Director at Fawkner Capital Management, a private equity investment firm, Chairman of CPT Global Ltd and XRF Scientific Ltd and a director of Select Harvests Ltd. He is also chairman of AUI’s Audit and Risk Committee and has been a director since 2014.
Dion Hershan is Managing Director and Head of Australian Equities at Yarra Capital Management and has more than 20 years of experience in the finance industry. He has held senior executive positions at various investment companies in the United States. He has been a director since 2018.
Overall I think AUI’s directors have extensive and broad enough experience to make good investment decisions. Remuneration of directors appears fair and reasonable in light of their substantial expertise. Note that Peter Wetherall is no longer a director of AUI and was replaced by Dion Hershan in early 2018 which is reflected in the lower than normal remuneration for FY18 for both directors since they each only worked for part of the year.
Since AUI has only four people who make the investment decisions for the company, you are putting a lot of faith in just a handful of people. Thus, we must dig deeper in to the way the company is governed to ensure that shareholders interests are protected. AUI is run on a day-to-day basis as follows:
“The Board usually meets eleven times each year and consults on investment matters between meetings. The Board has responsibility for day to day management of the investment portfolio. Transaction levels are low as the portfolio is held for the long term. The Board reviews financial statements, forecasts, the investment portfolio, the net asset backing per share, and compliance reports monthly. The Company Secretary is responsible for either providing the information or co-ordinating it from outside service providers.”
The Annual Report explicitly deals with Corporate Governance concerns and acknowledges that the Company departs from the ASX Corporate Governance Council’s Recommendations regarding having a majority independent Board. As stated in the Annual Report:
“Mr C B Goode, being a governor of The Ian Potter Foundation, is associated with a substantial shareholder. He brings significant and relevant experience to the Board. All other directors are regarded as independent. However, in that the Chairman of the Board is not independent the Company departs from the Australian Securities Exchange Corporate
Governance Council’s Recommendations. A lead independent director is not considered necessary given the small size of the Board. Appointed directors must stand for election at the next Annual General Meeting. One third of directors stand for re-election at each Annual General Meeting. There is no set retirement age or term for directors. Extensive experience in the investment markets is valued.”
While departing from the ASX recommendations is not ideal, it does mean that the company does not have to employ another director just for the sole purpose of meeting that recommendation. Whether or not you think this is an issue will depend on your opinion of Charles Goode and the other directors. I haven’t found anything which rings alarm bells. This bare bones operation is what enables the company to have low fees, in many cases being lower than the fees charged by ETFs.
AUI has performed remarkably well over the years. According to Bell Potter, AUI’s 10 year share price return including gross dividends is 11.7% per annum compared to the ASX 200 Accumulation Index return of 10.1% as at May 2019. AUI has consistently beaten, or at least closely tracked, the returns of the ASX 200 index.
According to this wonderful analysis conducted by Fully Franked Finance, AUI currently has the third best dividend streak on the ASX behind ARB and CSL. AUI’s dividend growth over the last 25 years is around 6.3% per annum, not bad at all I must say! Capital growth has also been substantial, averaging under 6% per annum. Note that the dividend was maintained during the GFC.
Perhaps the number one reason investors choose to invest in LICs over ETFs is the consistency (i.e. lack of volatility) of dividend payments. The consistent dividends are highly valued by many investors. While the total returns of an index tracking ETF may be higher, the volatility of dividends is generally higher than with a LIC, with dividends reaching record highs during a boom and then reducing drastically during a recession. Conservative LICs such as AUI do not pay out all of their dividends during the boom period meaning that they can still pay a stable or even growing dividend during a recession. This is highly valuable to individuals wishing to pay their expenses with dividends and in many cases is reason enough to justify investing in LICs over ETFs, despite total returns potentially being slightly less than the index.
Despite this stellar dividend performance, total returns have also been great with AUI’s Net Asset Backing Accumulation averaging 5.7% per annum for the previous 10 years compared to 6.4% for the ASX 200 Accumulation Index. As I said above, total returns will probably be a little less than the index but this will be made up for by the consistent growing dividends.
AUI operates with the bare minimum resources required to run an ASX listed investment company. It has only one employee, only four directors and no money is spent on frivolous expenses (just have a look at aui.com.au!). The company is the cheapest possible way a person could gain access to a diversified portfolio of shares on the ASX without investing in an index fund. Over the coming decades I think AUI will continue to deliver stable and predictable dividends to shareholders. I also recommend checking out Strong Money Australia’s AUI review for another opinion.