LIC investors getting more choice, but reducing benefit from discount to fair value in longer term


Dugald Higgins

Investors have more choice than ever in the asset class strategies offered through Listed Investment Companies (LICs), according to Zenith’s latest research report on the sector.

The expanding investment menu has been fuelled by a dramatic shift in the composition of the LIC market, which has grown 16% per annum over the past six years to reach $39.4 billion as at April 2018.

The biggest shift has been the sharp decline in the market capitalisation of LICs with an in-house investment team, down from 80% to 49% in the eight years to April 2018. Most internally-managed LICs focus on Australian shares.

Over the same period there has been a sharp rise in LICs that outsource their investing to external fund managers, which now account for 51% of the sector.

The rise in externally-managed LICs has seen the emergence of a far wider diversity of asset classes and strategies, including small companies, microcaps, long/short, Asian equities, fixed income and alternatives.

Zenith Head of Listed Strategies Dugald Higgins said “There is a clear trend towards externally managed LICs, with 92% of the capital raised in 2017 attributed to this segment. While we view the increased diversity positively, advisers should be aware that the performance of some types of strategies may be influenced by listed market movements in the short term.”

For example, ‘low beta’ LICs like market neutral strategies that aim to deliver returns with a lower correlation to markets, may have their short-term returns to investors amplified or detracted by LIC share price movements. This is expressed as a discount or premium to a LIC’s fair value, which can continuously change.

However, Zenith believes LIC investors with a long-term investment horizon should not be discouraged by what may go on in the secondary market, which is where discounts and premiums play out.

According to the Zenith Report, the positive or negative impact of market movements when investing in a LIC tends to dissipate over longer periods — beyond two years.

In pioneering research, the Zenith Report reveals that within the first year of investing, the degree of discount or premium at which a LIC is purchased has a significant impact on the total return to the investor. But beyond two years, the data indicates that whether an investor bought into a LIC at a discount or premium has far less bearing on long term performance.

Higgins said “while movements in share price relative to fair value may throw up advantageous opportunities to enter or exit positions in LICs, other drivers influence longer-term outcomes. This is important, as it addresses a widespread view held by the market that LICs are unattractive versus managed funds because of their ability to trade away from fair value.”

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