This article is for entertainment purposes only and is not intended as investment or financial advice. I am not a licensed financial advisor or professional investor. Make sure you seek personal and professional advice before making any investment decision. Read my full disclaimer.
Part I – LIC’s explained!
Listed Investment Companies (LICs) are a common investment vehicle in Australia, serving as an alternative to ETFs and managed funds. Because LICs are listed their shares can be bought and sold on a stock exchange just like a stock. This flexibility compared to a managed fund has helped make LICs popular with retail investors. Another key benefit of LICs is that a sale or purchase of shares doesn’t change the amount of funds available to the investment managers. This allows management to take a longer term view in their decisions, exercise patience and avoid unnecessary pressure to sell good positions or forgo buying opportunities in a down market when redemptions are typically more common.
One side effect of a ‘close-end’ structure is that the LIC share price can depart from the value of the underlying assets (usually other equities), so the share price can trade at a premium or discount to its Net Tangible Assets. When an LIC becomes wildly popular, it will usually trade a premium. Conversely, when an LIC is new, has had a poor track record is is generally overlooked, it often trades at a discount to its NTA. Sometimes LICs trade above or below NTA for no clearly apparent reason.
When management of an LIC wants to raise fresh capital for to make new investments, they usually do so via a share purchase plan / capital raising (e.g. issuing new shares to investors). Provided share offerings are done at around NTA they’re generally fine. If they’re done at a steep discount to NTA, perhaps to attract new investors, then exisiting shareholders are getting a raw deal!
The fee structure of an LIC is often similar to a managed fund, but they’re typically less expensive to run. There’s usually a management fee (e.g. 0.8%) and often a performance fee (e.g. 20% of positive returns above some hurdle rate). This is essentially what you pay to cover the cost of running the LIC (research, brokerage, management and admin salary etc) and to ‘reward’ management for good performance. One important fact to remember is that very few active management teams out-perform their passive benchmarks over the long term (e.g. an index ETF). Read my post about active vs. passive management here. Some LICs have very low fees. Australian Foundation Investment Company (AFIC) is Australia’s largest LIC and has a total fee of just 0.14% p.a. Argo Investments Ltd. has a fee of 0.16% p.a. – both of these LIC’s are actively managed and have a reasonable amount of the standard large caps in their holdings. Neither charge a performance fee. By way of comparison, Vanguard charge a management fee of 0.14% p.a. on their Australian Shares ETF.
Because an LIC has a company structure, they usually pay a fully franked dividend. This makes them an attractive proposition for dividend investors or individuals in high tax brackets!
LIC’s provide additional diversification. With just one LIC, you might be investing in between ten and hundreds of underlying companies across a range of geographies and sectors. With some exceptions, if an LIC charges a high fee (e.g. > 0.8%) and is so diversified it resembles an index you might as well save on the fees and purchase an index ETF. This diversification makes LIC’s attractive to investors just starting out or investors with small amounts of capital to invest that preclude diversification at a reasonable brokerage cost.
Some exposure to active management. You’re right, I earlier got through suggesting active management rarely beats passive management over the long term, net of fees. That’s not true for every sector though. And it isn’t true for every management team. If you can identify a team with a solid track record (e.g. over 7-10 years), you might decide their outperformance is worth paying for.
Due to ASX corporate governance requirements, LIC’s are usually very transparent. Additionally, the top holdings and NTA are generally published monthly, much like a managed fund.
Some investors want to strategically be overweight certain sectors (e.g. technology), geographies (e.g. asia) or themes (e.g. disruptors). LIC’s with a similar investment strategy can provide a good opportunity for the strategic investor or the investor who doesn’t want to do too much work but would like a little active stock picking in their portfolio.
Whilst most LIC’s are quite liquid (heavily traded enough to permit easy entry and exit) some are illiquid and thinly traded. If you need to sell fast, or have to compete with a tsunami of fellow shareholders selling out (e.g. market crash) it might be hard to get your money out at the price you desire.
Departure from NTA is both an advantage and disadvantage. Unlike a unit trust, the price of a share of an LIC can vary from the underlying asset value. If you’re a buyer, a discount to NTA may present an opportunity to buy the basket of companies held by the LIC for a discount to their collective stock market price. If you’re trying to sell at a discount to NTA, you are getting less than the market value of the underlying holdings. If you’re a seller, you’d most likely welcome parting with your holding for more than the underlying assets are worth, but if you’re trying to buy in you might have to wait for a more reasonable price, or pay the premium.
NTA ≠ value! Investors sometimes get confused that because they’re buying an LIC at a discount to NTA it represents good value. The NTA represents the market price of the underlying securities if everything was sold up for you that day. It doesn’t represent the intrinsic value of the underlying holdings. So an LIC can trade at a discount to NTA but still be composed of or be actively buying overpriced companies. If you’re not a value investor, this might not bother you too much – but nobody I’ve met yet wants to overpay for an investment. The best thing to do is check the ‘Investment Philosophy’ section of the LIC’s parent website which usually tells you how management identify possibilities and make investment decisions. Ultimately, the price you pay determines the return you achieve.
This marks the end of your brief primer on LIC’s. Part II will explore in a fairly simple way how to analyse and buy an LIC for your portfolio!
I hope you enjoyed this article! Let me know what you think and if you have any experience or suggestions of your own, add them in the comments below!