The earliest Listed Investment Companies (LICs), Australian Foundation Investment Company (AFIC) and Argo, were launched in 1928 and 1946 respectively.
More recently there’s been a resurgence in this investment class, with 22 new LICs launched during the two years to 30 June 2016, an increase of nearly 25%. In this article, Grant Samuel Funds Management will unpack the LIC and examine the factors driving this growth.
What is an LIC?
An LIC is a listed, collective investment vehicle that provides investors with a diversified exposure to one or more asset classes. These might include Australian and global shares, property, fixed income and cash, and more recently, alternative investments. Investors buy and sell shares in an LIC in the same way they would in any listed company or exchange traded product (ETP).
LICs are incorporated as companies and are closed-end funds. They issue a fixed number of shares through an initial public offering (IPO) and investors then buy and sell those shares on the Australian Securities Exchange (ASX). Like other listed companies, new shares may be issued to increase the size of the investment pool, or shares may be cancelled or bought back to reduce its size.
The closed-end structure allows the investment manager to focus on investment selection and portfolio management without having to factor in fund inflows or outflows.
As a company, LICs generally pay fully franked dividends. These are sourced from the underlying investment portfolio and from company tax paid on its own profit. As noted in the Zenith Investment Partners (Zenith) Sector Report on Listed Investment Companies (June 2016), this makes quality LICs a strong contender for income generation strategies, particularly on a post-tax basis.
LICs offer many of the advantages of direct share ownership, without the time and effort that managing a share portfolio generally demands.
The LIC market
At 30 June 2016 there were:
- 90 LICs listed on the ASX
- A total market capitalisation of $29,454,374,899
- During June 2016, there were 50,666 transactions
As illustrated in Figure 1, the majority of LICs are Australian equity based. Interestingly, the majority of funds flow during this period went to the oldest LICs, AFIC (38%) and ARGO (23%); it’s not surprising then, that 76% of the value traded in LICs during June 2016 was in Australian equities.
ASX data shows that annualised LIC liquidity is just 11.77% – when compared to the likes of ETPs (98.78%) or A-REITS (74.4%), the data suggests that a number of LICs are thinly traded.
Zenith’s Sector Report noted that outside the very largest LICs, liquidity can be comparatively limited; as such, Zenith believes that many LICs are best suited to patient, longer-term investors.
Pricing LICs
The value of an LIC’s underlying assets is called its net tangible assets (NTA); each LIC should trade close to the value of its NTA, minus ongoing fees. ASX trading rules require LICs to regularly report their NTA, which can be used to determine whether than LIC is trading at a premium or a discount.
If trading at a premium, its share price is trading above its NTA – if trading at a discount, its share price is below the NTA. As illustrated in Figure 4, there is a wide dispersion among those trading at a premium or discount, and some of the outliers vary significantly from the NTA.
While the NTA should be close to the value of the underlying investments, LICs can also be subject to investor sentiment. According to Zenith’s Sector Report, there are several issues that can be a positive or negative impact on price:
- Investor sentiment
- Portfolio performance and share price performance
- Investment management fees
- Shareholder’s trust in the Board and their engagement with shareholders
- Market capitalisation and liquidity.
According to a report published by Morningstar, research has identified that $200 million is the threshold below which an LIC will generally trade at a discount. LICs over $500 million tend to trade at a premium. The rationale is that fixed costs of, for example, $1 million on a fund size of $40 million, will have a greater impact on performance than on a portfolio size of $200 million.
The new breed of LICs
A number of LICs that have been launched in recent times are managed funds repackaged in the LIC structure. As noted in Zenith’s sector report “…the theme where fund managers operate LICs alongside unlisted managed funds utilising a largely parallel investment strategy has continued.” Zenith views this trend as largely positive, as it believes “the creation of multiple entry points into an investment strategy provides more flexible options to service different consumers with different needs.”
Why are fund managers launching LICs?
Firstly, the large growth in SMSFs; statistics suggest a preference for listed investments. According to the ATO’s SMSF asset allocation data at 31 March 2016, SMSFs held over $195 million in Australian listed investments and just $84 million in unlisted investments.
Secondly, Zenith considers the sector attractive to fund managers because an LIC creates a captive pool of fee generating funds which is not subject to the ebbs and flows of an open ended vehicle; a market downturn won’t see investors – and their money – scurrying for the door.
Those managers operating income-focused funds might find the LIC particularly attractive – income from the underlying investments plus dividend income from the LIC may enable the manager to provide higher levels of income. If the underlying investments are not Australian shares, it also enables the manager to provide some franked income, something not possible through a managed fund structure.
Different investment structures suit different investors. It certainly seems the proliferation of managed account and other platforms are fuelling investors’ appetite for listed investments.
——–
You must be logged in to post or view comments.