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Are LICs all they're cracked up to be?

Glenn Freeman  |  29 Sep 2016Text size  Decrease  Increase  |  

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Listed investment companies hold some advantages over other ETPs but you need to be aware of the risks you bear.

 

These ASX-traded investment vehicles are enjoying something of a renaissance, offering growth and income, diversification and reasonable liquidity--and they aren't ETFs.

Twenty new listed investment companies (LICs) have been brought to market since 2013, with a number of others still in the pipeline. While these present an investment opportunity distinct from direct equities, managed funds, ETFs and mFunds, there are a number of characteristics you should be aware of.

"While LICs in some respects appear simpler than unit trusts in terms of less paperwork, investors need to be aware of the additional market risk they incur, as the shares can trade in a wide range around the underlying net tangible assets," says Michael Malseed, senior analyst, manager research, Morningstar Australasia.

Click here for a more detailed article on LICs and how they work.

Liquid enough?

In terms of whether LICs provide you with the right level of liquidity, the simple answer is: it depends.

You can draw comparisons with ETFs, which create units in much the same way as a managed fund--using a market maker--and with fund flows.

"That's why an ETF's price is more closely anchored to the underlying NTA, whereas a LIC is able to be traded purely on the base number of willing buyers and willing seller of an existing fixed asset pool," Malseed says.

This is where the all-important selection of the appropriate LIC for your individual situation comes into play. Larger funds are more liquid, with a steady pool of buyers and sellers, but as Malseed suggests, if a LIC is under around $50 million of total book value, liquidity will be quite low.

Comparing and contrasting LICs and managed funds, liquidity is comparable in both vehicles.

"However, if there's a rush of sellers [for a LIC], it will trade at a discount to its NTA," he says.

Taxation

Tax effectiveness is one of the main perceived advantages of LICs, over other exchange-traded products.

"Managed funds are tax transparent, so all taxable income and capital gains are distributed to the unitholder every year," Malseed says.

"Whereas all of the returns of the fund in a LIC are taxed at the company tax rates inside this, which creates franking credits, which the LIC can distribute in a smooth manner to shareholders through dividends. But it's swings and roundabouts, because the company tax that [the LIC] is paying is just decreasing their NTA by the same amount.

"LICs have seen a resurgence since about 2012. It's about the appeal of franking credits to investors, it's the ease of trade relative to unit trusts, and it's the lower administrative burden--which all combine to make them particularly popular in Australia.

"But investors need to be aware that they bear additional market risk with LICs, whereby shares can trade at a discount to NTA."

More from Morningstar

What you need to know about listed investment companies

Comeback kid: emerging markets

 

Glenn Freeman is Morningstar's senior editor.

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