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400 million reasons to invest in LICs

Anthony Fensom  |  01 Jun 2016Text size  Decrease  Increase  |  

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Australia's listed investment company (LIC) sector is on the rise, with new listings and strategies adding to the options for investors. However, with LICs often trading at a discount or premium to the underlying assets, there are different considerations compared to investing in exchange-traded funds (ETFs).

More than 30 LICs have listed on the ASX since 2012, increasing their total number to 87 as of April 2016, while their market value doubled to $30 billion over the same period.

According to the Australian Investors Association, LICs are a viable alternative to managed funds, enabling an investor to invest in a diverse and professionally managed portfolio of assets which can include shares, property and fixed income.

Benefits of LICs include the ability for Australian investors to access franking credits and gain exposure to a diversified portfolio or strategy which is transparent and tradeable, although LICs are prone to market volatility and some may trade at a considerable discount or premium to the value of the underlying assets, known as their net tangible asset (NTA) backing.

The discounts and premiums can vary widely, with the ASX's 30 April 2016 LIC report showing as high as a 60 per cent post-tax NTA discount for Orion Equities (OEQ), while the Australian Masters Yield Fund No. 1 (AYD) was trading at a nearly 76 per cent premium.

LIC heavyweights include the Australian Foundation Investment Company (AFI), with a market capitalisation of around $6.3 billion at 30 April, and Argo Investments (ARG), worth $4.9 billion.

Morningstar analyst Matthew Wu has described AFI as "an excellent low-cost option for Australian equities exposure … backed by a highly experienced team," while ARG also offers a "proven, low-cost option for Australian equities exposure".

Smaller funds include the $1.7-million market value Millinium's Alternatives Fund (MAX) and $2.9-million Sunvest Corporation (SVS), while some of the newer strategies on offer include the "absolute returns" pursued by Watermark Market Neutral (WMK) and the "global arbitrage" style of Global Value Fund (GVF).

"The rise in LICs reflects the growth in self-managed super funds (SMSFs) over the past few years. LICs have become popular with SMSFs due to their potentially lower costs, transparency and increased familiarity," Wu says.

According to the latest ASX report, ARG's management expense ratio (MER) was just 0.15 per cent and AFI's was 0.17 per cent, although the Australian Leaders Fund (ALF) charged 2.7 per cent.


Gap narrowing

The gap between LICs' market value and the value of their underlying assets has narrowed in recent years.

According to Paterson Securities, the average discount has dropped from around 11 per cent in 2011 to just 1.9 per cent recently, reflecting an increased preference for transparent, low-cost investments following a crackdown on commissions paid to advisers, along with LICs' access to fully franked dividends.

Weak investment performance and a poor record of paying dividends can increase the discount, along with a lack of marketing and communication initiatives. LICs, which consistently trade at a discount to their NTA backing, can attract activist investors, or potentially face calls for the investment manager to be changed or the fund wound up.

The converse applies to LICs trading at a premium, which also enhances their ability to raise capital for more investments. However, investors can benefit if a LIC trading at a discount moves closer towards its net asset value.

"Some managers have been quite proactive about managing their discount or premium to NTA, for example, by doing share buybacks to close the gap," Wu says.

Morningstar chooses which LIC strategies to cover based on its guiding principles of investment merit, client demand and strategy size, with the final Morningstar Analyst Rating also incorporating a manager review based on the "five P's" of people, process, parent, price and performance.

"At the end of the day, a LIC is a fund manager ... [and] the main emphasis is the investment merit," Wu says. "That said, we are hesitant to recommend investors buy a LIC that's trading at a significant premium to its NTA."

The continued interest in LICs is shown by the success of large-cap-focused WAM Leaders Limited (WLE), which commenced trading on 30 May after raising nearly $400 million from investors.

"The breadth of listed strategies will continue to grow as fund managers try to catch the SMSF wave," Wu says.

"However, LICs are competing against other listed options for a piece of the pie, so it's hard to see how it will play out."


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Anthony Fensom is a Morningstar contributor. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind.

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