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LICs facing stiff competition

Nicki Bourlioufas  |  12 Apr 2016Text size  Decrease  Increase  |  

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Nicki Bourlioufas 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.


Some listed investment companies (LICs) can offer the best of both worlds--lower costs compared to traditional managed funds while at the same time being actively managed, offering the potential to outperform benchmark indices and rival exchange-traded funds (ETFs).

But it is dangerous to generalise and active management can be a double-edged sword, with some new LICs being more expensive than managed funds or ETFs, according to Morningstar.

LICs have been around for many years and their active management approach makes them similar to managed funds. LICs hold a portfolio of assets across shares, property, cash and other assets in one corporate entity that trades on the Australian Securities Exchange (ASX). As a result, LIC securities can be easily bought and sold and are therefore more convenient to access than unlisted managed funds.

Well-established LICs include the Australian Foundation Investment Company (AFI) and Argo Investments (ARG), both of which have attracted an army of retail investors, especially retirees.

"Some of the older LICs have quite low management fees, as little as 15 basis points for Argo, but some of the newer LICs such as Perpetual Investment Company (PIC) and Platinum Asia Investments (PAI) are charging comparable fees or are even more expensive than some actively managed funds and ETF options," says Matthew Wu, a manager research analyst at Morningstar.

Moreover, even though actively managed LICs offer the prospect of outperformance, it is not guaranteed. If management gets it wrong, a LIC can underperform. Furthermore, whether a LIC's portfolio outperforms or not, the vehicle is still exposed to market volatility.

"There are two components to a LIC's performance. The first is what the underlying portfolio does. The second component is whether the portfolio trades at a premium or discount to its pre-tax net tangible assets (NTA)," says Wu.

In recent times, some of the more established LICs have been trading at a premium to their pre-tax NTA.

"For example, popular LICs like Argo and AFI have been trading at a moderate premium (of up to 10 per cent) to their pre-tax NTA for the past two to three years. This reflects how LICs can trade at a premium or discount for extended periods," says Wu.

"That's why we suggest investors hold LICs as a long-term investment rather than as a short-term holding, as it is difficult to predict what will happen to the premium or discount to NTA."

Wu also points out that LICs can retain some of their profits in particular years and not pay out all of their profits in the way that managed funds and ETFs do.