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Why I think this small-cap LIC is a buy for its 8.6% dividend yield

Picking your own shares can be tricky and time consuming.  That’s why some of us are happy to outsource this job to investment managers.

Listed investment companies (LICs) are a great way to build a diversified portfolio with just a couple of holdings.

Here’s one LIC which focuses on the small end of the market, where the management team has built up a good track record so far…

Naos Emerging Opportunities Company Ltd (ASX: NCC)

Naos Emerging Opportunities Company has been listed on the ASX for around 5 years.  The company holds a concentrated portfolio of stocks outside the top 100, currently holding just 9 companies which management follow closely.

Since inception, the portfolio has outperformed the market comfortably, before and after fees. 

From figures published by Naos, growth in asset value per share (NTA), including dividends has been around 11% per annum, or roughly 13% per annum including franking (my estimate).

That compares favourably to the benchmark’s return of 8% per annum.

Shareholder returns have been well balanced, with around half the return coming from dividends, and the other half from capital growth.  This is much better than some LICs, which pay out almost all their growth as dividends, and in turn, the NTA struggles to grow at all.

By balancing growth and dividends, it underpins more sustainable dividend growth going forward.

The Naos management team owns a substantial amount of the shares which helps provide some alignment with shareholders.

The company has also provided a strong and growing income stream over time, having increased the dividend every year since listing.

Risks

One of the major risks is stock selection. Naos has done a good job so far, but after 5 years, it’s still early days. Due to the concentrated nature of the portfolio, one or two poorly performing companies could really hurt this LIC.

Another risk I see is the fees. At 1.25% per annum, and an outperformance fee of 15% over the benchmark, it’s not small biscuits. The fees obviously eat into the shareholders’ return and a bad patch of performance is likely at some point. Something to keep in mind.

Foolish takeaway

Naos Emerging Opportunities is a relatively high risk LIC in my view. Because of this, I personally look at it more like an individual stock.

Naos Emerging Opportunities is currently trading at a 7% discount to NTA, and a gross dividend yield of 8.6%.

At the current price it looks quite cheap. Whether you’re looking for income or growth, I think it’s worth considering.

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Motley Fool contributor Dave Gow owns shares of NAOS EMERGING COMPANIES FPO. 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 Scott Phillips.

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