LIC’s – Listed Investment Companies
The standard way investors achieve exposure to a range of assets by way of a single investment is usually through a managed fund. Unfortunately, fund managers charge like wounded bulls for their ‘expertise’. So the costs of adopting this strategy can sometimes outweigh the benefits. Or at the very least fail to give the value for money you would have liked.
Probably the cheaper alternative to a managed fund is an index-linked Exchange Traded Fund (ETF). These products have become the new ‘black’ when it comes to investing. There are literally hundreds of options available and an ETF does represent good value for money.
Fortunately, there’s an alternative and it’s called a Listed Investment Company (LIC) A LIC is a way to achieve much market diversification and will particularly suit an investor who doesn’t have the ability or inclination to do it themselves.
Simply, a LIC is a listed company that uses its capital to invest in other listed securities. They primarily invest in Australian or global shares, which are exactly the same assets offered through your standard managed fund. In fact, there is often a great deal of portfolio similarity between a lot of LIC’s and a corresponding managed fund.
A Stable investment portfolio
The truly great advantage that LIC’s have over managed investments is the stability of their underlying portfolios. LIC managers are declared long-term holders of shares (in most cases) This reduces their capital gains tax liabilities, costs associated with trading and gives them the ability to maximize dividend imputation credits. All of which reduce ongoing costs and leads to a constantly growing dividend stream for the investor.
Particularly in regard to the more established LIC’s, this long-term investment philosophy nicely mirrors lot’s of individual investors ‘buy and hold’ strategy. The LIC is, therefore, a perfect fit for many portfolios.
Because LIC’s are listed entities, they don’t need to carry stockpiles of cash for redemptions. This is because a LIC is classed as a closed-end investment. Which simply put means you’re not investing in the fund but rather buying a share of the profits.
Managed funds, on the other hand, need a certain level of cash to cater for redemptions. As a result, a portion of total investable funds will always be invested at the cash rate, and you know how good that rate is!
This fact becomes quite problematic during times of market falls. Investors tend to liquidate holdings during these periods, thus increasing managed fund redemptions. To cater for these increased redemptions, fund managers are forced to liquidate assets at exactly the wrong time, when the price is dropping. This, in turn, can have a disastrous effect on an investment portfolio’s strategy.
When to buy a LIC
For all long-term investors, looking at adding a LIC to their portfolio, the usual cycles apply. At times of investor optimism, prices are driven upwards, and as a high tide lift’s all boats, LIC prices will trend up. On the contrary, LIC’s will also follow the market down during times of pessimism.
However, there is a simple buying trigger or signal to watch for when you are in the market for a Lis- ted Investment Company. That signal is the Net Tangible Assets or NTA. The NTA of any LIC is simply the total value of their share investments less any liabilities. Therefore if the NTA value per share is less than the current price per share, you can consider the LIC overpriced. As you will be buying assets at a higher price than what they are actually valued at.
Conversely, when the current price of a LIC’ shares is lower than the total NTA per share, you are now buying their assets at a discount. Therefore it is an incredibly easy process to buy ‘value’ when choosing to invest in a Listed Investment Company.
It is up to the individual investor when to buy and sell of course, but the NTA is a particularly strong indicator to follow. The NTA figures are easy to get hold of directly from the LIC’ or via online broker sites.
But a word of caution. There are times when the quality of the underlying asset’s in a LIC have be- come rather dubious and large discounts to NTA may actually be ringing a loud warning bell. So always do your homework or if in doubt, seek a professional opinion.
With a LIC – the big difference is fees
The big point of difference from a managed fund is the fees. Because of their structure, a LIC is not subject to the same costs as a managed fund. You can imagine just the printing of PDS’s alone adds
enormous costs to any managed investment. And there are much more requirements besides, for a fund to meet their compliance obligation. All of these costs are borne by the investors.
On the other hand, well established LIC’s such as Argo Corporation and Australian Foundation In- vestments Corporation (AFIC) have total fees of around 0.2% pa with returns of 10%. (Approx figures which don’t indicate future returns.) This compares remarkably well to the 1.5% plus of the standard managed fund.
But be aware that there are plenty of newer LIC’s on the block, whose fees are higher, so always check carefully before proceeding with a purchase. You are really after a balance between the fees and returns.
But beware performance fees
Also on fees, keep your eyes out for a lot of ‘mumbo jumbo’ when it comes to benchmarks and performance fees. You may see terms such as ‘high water mark’, ‘index agnostic’ ( in fact any phrase using the word ‘agnostic’ ) or other flowery grammar. This is usually where some hefty fees are lurking, so stay sharp!
Performance fees, in particular, should be looked at very carefully, especially when they can be up to 20% of the out-performance. These types of extra fees never sit well with me, because they always seem difficult to actually calculate. (Contrary to what the manager would have you think)
The fee is on top of all else and is sliced off any ‘over’ performance of the benchmark return. For ex- ample, the manager may decide that a reasonable return would be the current inflation rate plus an extra 5%. Therefore if inflation is 2.5%pa, just add 5% and bingo you now have a benchmark, 7.5%. The manager will strive to make this annual return. Should they meet it and then exceed it, the ex- cess above the benchmark rate, 7.5%, is shared between you and the manager.
The fee is supposedly included in order to motivate the manager to exceed performance benchmarks. It is, however, just an extra cost to be considered when making an investment.
A recent press article from the Financial Review actually gives some fantastic detail around this is- sue and more! Take a look here and be ready to be shocked as to, not only the fee ‘sucking’, but the type of risks that can be involved in these newer LIC’s!
Conclusion
Finally, an interesting aside about one of the ‘old school’ LIC’S, Argo Investments. Would you believe that the late Sir Donald Bradman, Australia’s greatest ever sportsman, was their chairman for many years? Now that’s what I call a ‘blue chip’ pedigree.
So there you have it, a LIC is a great product that provides an investors with an experienced management at a cost normally associated with index funds. They’re certainly worth having a look at for future investment. But as always, do your research and make sure you seek professional advice before making any decisions.
Thanks for reading and see you next time. Homepage
