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Are these listed investment companies safe in a share market crash?

My wife has been an investor in the Forager Funds Australian Fund now for a number of years and we’re pleased to say we’re happy with the performance of this investment.

It was an unlisted managed fund until December last year when it converted itself to a listed investment trust where it’s now known as FORAGER AU UNITS (ASX: FOR).

Forager’s Australian Shares Fund’s top 5 investments to 30 June 2017 were Macmahon Holdings Limited (ASX: MAH), Reckon Limited (ASX: RKN), NZME LTD FPO NZX (ASX: NZM), Cardno Limited (ASX: CDD), and Enero Group Ltd (ASX: EGG).

Their willingness to depart from the index and focus on special situations sets them apart from many of their competitors in my opinion.

But funny things can happen when a managed fund closes and lists itself on the ASX.

The value of a fund at any point is now set by the on-market buyers and sellers of its securities, and the fund’s day-to-day value is less influenced by the pre-tax Net Asset Value (NAV) of its underlying investments.

In Forager’s case, there’s clearly an emotive reaction to Forager’s excellent past performance and investors are bidding the price of the Forager Australian Share Fund up well above its underlying value.

This is happening because of two things:  there are a lot of satisfied existing investors — my wife included — who don’t want to sell, and there are new investors wanting a piece of the action.

The result is that Forager’s listed Australian Shares trust is now trading at $2.11 per unit, well above its most recent pre-tax NAV of $1.75.

That’s a 20% premium!

Investors buying these units at well above its pre-tax NAV have been warned though.

Forager’s Chief Investment Officer, Steve Johnson, has tempered expectations by advising to not extrapolate its recent history of 25%+ returns that it achieved over the last 12 months.

Which is why I think the current listed unit price is a little silly.

There are other listed investment funds [listed companies or LICs in this case] out there too with a similar problem, including the ones below:

LIC Pre-tax NAV ($) Recent price Premium Top 5 investments
Mirrabooka Investments (ASX: MIR) 2.39 2.75 15.0% Qube Holdings Ltd (ASX: QUB), Lifestyle Communities Ltd (ASX: LIC), Mainfreight Ltd, ALS Ltd (ASX: ALQ), Iress Ltd (ASX: IRE)
Bki Investment Co Ltd (ASX: BKI) 1.61 1.64 1.8% Commonwealth Bank of Australia (ASX: CBA), National Australia Bank Ltd. (ASX: NAB), Westpac Banking Corp (ASX: WBC), Australia and New Zealand Banking Group (ASX: ANZ), Wesfarmers Ltd (ASX: WES)
Platinum Capital Limited (ASX: PMC) 1.6501 1.74 5.4% Samsung Electronics, Alphabet Inc, Lixil Group Corporation, Tencent Holdings, Oracle Corporation
Djerriwarrh Investments Limited (ASX: DJW) 3.24 3.61 11.4% Commonwealth Bank of Australia, Westpac Banking Corp, BHP Billiton Limited (ASX: BHP), National Australia Bank Ltd., Australia and New Zealand Banking Group

Foolish takeaway

If you’re going to invest in a listed investment company or trust, I think you’d be better off by buying at or less than its pre-tax NAV which will give you a margin of safety.

Paying too much can leave you exposed to a nasty capital loss, a) because of the fall in the underlying investment, and b) because of the possibility of unitholders in the respective listed investment funds bailing out.

Given the choppiness of share markets in the short-term, it wouldn’t take much to see a material decline in the underlying value of funds under management.

But of course, you shouldn’t just look for ‘cheap’. You also need to look for a manager that has an investment strategy that aligns with your personal investment philosophy, and doesn’t charge an exorbitant amount in fees.

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Motley Fool contributor Edward Vesely owns shares in the Forager Australian Shares Fund. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.