In this post we’re going to take a look at Listed Investment Companies, LIC’s. They’ve been around a long time on the stock market, and given the advancements made, especially in the Exchange Traded Fund (ETF) space, it’s worthwhile to question whether LIC’s still have a reason to exist. Should we as investors have them on our radar?
This week’s topic came up as a result of a question from one of the Financial Autonomy community members, Kieran, who emailed me late last year.
Let’s start with some definitions and some distinctions. A listed investment company, LIC is an investment fund that will then hold a portfolio of underlying shares. In that sense they’re very similar to a Managed fund, and indeed an Exchange Traded fund too. The most well known LIC’s are Australian Foundation, Argo, and Brickworks, which you might have heard of.
Listed investment companies have been around a long time, since 1923 in Australia. Therefore they predate Managed funds and certainly ETF’s. They were the original way that investors could, in a single trade, buy a diversified portfolio of shares. As the name implies these funds are listed on the stock market, which is different to a managed fund. The advantage of being listed, just like with an ETF, is that it’s easy for an investor to get in and out.
A key difference between Listed Investment Companies and the other fund options is that they are what is known as “closed end funds”. This means that when they are first established they have a float and raise capital from investors and after that point, no new capital is typically added or subtracted. This is really significant because this fixed capital leads to the main problem seen with LIC’s.
The price of an ETF or Managed fund for an investor who wants to commence an investment, or exit their investment, is determined by the value of the underlying portfolio. If there is a flood of people who want to enter a Managed fund or ETF, new units are created to absorb those new monies, and investments are purchased with those new monies to enlarge the fund’s share portfolio. The same happens in reverse if there is a wave of sellers, the portfolio gets sold down, and units in the fund are cancelled. This results in investors reliably getting a fair price that very closely reflects the value of the underlying investments that the fund holds.
The price that you buy and sell an LIC’s at however is determined purely by supply and demand for the particular LIC. There is no mechanism to easily create more units when demand is strong, or cancel units when there’s a stampede for the exits. If you want to sell but no one wants to buy, you’re stuck, or more likely, will have to sell at a significant discount to a bargain hunter. It could be for instance that if you totalled up the current value of the share portfolio that the LIC’s owns, and divided that by the number of shares on issue, each share should be worth $10 a share. However if there are few people looking to buy that LIC, you might find that the best you can get for it is $9 a share.
The underlying value of an LIC is known as the Net Asset Value commonly abbreviated as NAV. Most LIC’s will have this listed on their website as a way to try and direct investors to trade somewhere near fair value. The bigger LIC’s such as Australian Foundation do tend to trade pretty close to their NAV. But a common problem with LIC’s, and for me the key reason why I don’t use or own them, is that the bulk of them trade at something less than their Net Asset Value. Now you could argue that as a buyer this is great. But at some point you’re going to hope to be a seller, and if there’s a discount coming in, who’s to say the discount won’t be bigger on the way out? I’d much prefer to own an ETF or managed fund where I have certainty that on my way in, and on my way out, I’m going to get a fair price reflecting the value of the underlying holdings.
Active vs Passive
Another difference between LIC’s and ETF’s in particular is that LIC’s are actively managed. In this sense they’re more like a traditional Managed fund. We’ve covered in past episodes the difference between active and passive management (ep 58), you’ll recall passive management typically tracks an index, with Vanguard perhaps being the most famous passive manager, although of course there are many others. Active management is attempting to add value by researching and choosing stocks that they feel are likely to outperform, whilst avoiding stocks they expect to underperform. As with traditional managed funds, the challenge is for this outperformance, if it can be achieved at all, to be sufficient to cover the extra cost of doing this active management. Whilst some active managers are consistently successful, and active management has been shown to add value in particular sectors, broadly, passive index management has proven to be a more successful solution for most investors.
I found some interesting research from Stockspot which stated that 80% of Australian share LIC’s failed to beat their relevant market index over a five year period. They noted that you would have 14% more money had you invested in an Australian index ETF five years ago rather than the three largest Australian share LIC’s. Only one in 10 LIC’s tracking broad global indexes were able to beat their relevant market in the past year. They also noted that the average management fee for an LIC was over 1% which is significantly more than typical ETF’s and according to Stockspot on average LIC’s were trading at a 10% discount to what the actual underlying portfolio is worth.
In Kieran’s email to me, he noted that he held both ETF’s and LIC’s, and something he’d appreciated last year was that the dividend stream from the LIC’s was more stable. An ETF simply distributes to its investors all the income that it receives in a given period. In contrast, because of the active management nature of LIC’s, they payout dividends at the discretion of management. They can therefore elect to hold some cash back, and then in a period where dividend income from the portfolio is low, they can use some of those cash reserves to maintain a steady dividend payout to investors. I guess in some cases this could be seen as an advantage, but to me they’re just holding back my money. Personally I’d rather accept the volatility and have the money in my pocket where I can decide what I want to do with it, rather than a fund manager make that decision for me.
As you probably figured out by now, I can’t see any reason to still use LIC’s now that we have ETF’s available. Even if you’re a believer in active management, there are now active ETF’s coming out that could scratch that itch for you. ETF’s provide the same function as LIC’s in giving you a diversified portfolio in a single trade, however they do so at a significantly lower price, and whether you’re buying or selling you have the confidence of knowing that the price accurately reflects the value of the underlying assets that the fund owns.
If you already hold LIC’s, there may be capital gains tax reasons for retaining them.
Of course as always I should add that I’m not giving you advice, because I know nothing about your circumstances. I’m simply sharing with you my thoughts and experience; I hope you find it helpful.
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