This article appeared in the September 2011 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.
Here are nine common questions investors ask about Listed Investment Companies.
By Boyd Peters, Contango MicroCap
1. What is an LIC?
LICs have characteristics of both managed funds and ASX-listed companies. Essentially, an LIC is a company that invests in other companies with the purpose of giving its shareholders cost-effective exposure to a variety of companies through its investment portfolio.
2. Why invest in an LIC instead of an unlisted managed fund?
LICs are increasing in popularity for several reasons, including:
- Simplicity - you place your order to buy or sell on ASX as you would for any company.
- Cost - management fees can be as low as 0.15 per cent per annum.
- Access - some investment managers are only available through an LIC.
- Certainty of income.
Since legislative changes in 2010, LICs are able to pay a dividend even when there is a negative return (the company posts a loss). This is important because it means LICs can establish firm dividend policies and smooth dividend payments to shareholders, whereas managed funds must distribute all income generated.
Another benefit of LICs is that they typically pay fully franked dividends, and for those with self-managed super funds (SMSFs) and retirees this is added value that is not always reflected in the share price of the company.
Also, many LICs offer dividend reinvestment plans (DRPs). These new shares can be issued at a discount (usually around 2-3 per cent) to the prevailing share price.
From time to time you can buy an LIC at a discount to its actual asset value, which can be seen as a potential opportunity that may be realised in the future.
|How an LIC compares with shares and unlisted managed funds||LIC||Ordinary shares||Unlisted managed funds|
|Exposure to diversified portfolio of securities from one transaction||Yes||No||Yes|
|Cost-efficient||Yes||Yes||Not as efficient|
|Transparency of performance||Yes||Yes||No|
3. How can I measure the performance of an LIC?
There are three commonly used references in measuring the performance of an LIC.
1) Share price (plus dividends).
2) Growth in the net tangible asset (NTA) value of the portfolio.
3) Performance of the underlying securities held.
There is nothing improper in identifying all three, as this enables investors to make informed decisions on:
- Market sentiment to the company.
- The LIC structurally.
- The skills of the portfolio managers.
Essentially, the difference between portfolio performance and NTA reflects such factors as the impact of capital actions of the company; and fees, charges and taxes paid out in the ordinary course of the fund's operation.
The difference between NTA and share price is largely market sentiment; that is, expectation of future earnings, skills of the manager, structure of the company, dividend outlook, anticipated capital actions, and so on.
4. Sometimes I see various NTA values for a company. What are they?
Each month you will see two net tangible asset (NTA) figures. One is pre-tax and the other post-tax. The pre-tax is something of a misnomer because it includes tax that has already been paid by the company. It also is a figure after fees and charges. Post-tax reflects the value of the company if it were wound up and all its holdings sold. Some LICs have been around for more than 60 years and most have no intention of winding up.
5. What do I look at when comparing performances?
When assessing and comparing investment performance between LICs it is important that returns are measured and compared on a like-for-like basis. Most importantly you should:
- Compare before-tax and after-tax returns of an LIC with those of an index or similar LIC.1 2.009
- Ensure the index or LIC used as a comparison is one that invests in the same market.
LIC returns based on share price or pre-tax asset backing are generally not a pure basis for comparing one LIC against another. Both measures are only partially after-tax measures, which may be heavily skewed by the timing of tax payments and may not reflect tax credits provided to investors.
6. Is share price the best measure of performance?
In many instances it is. Essentially share price movements plus dividends (and franking) measures the true return provided to shareholders. Be sure to recognise that, like any other company, an LIC may have undertaken capital actions (for example, share splits, consolidations or returns of capital) which affected the share price you are looking at.
Although stockbrokers and researchers have the tools to generate the total return for an LIC, investors need to do their homework on an LIC to ensure like-for-like comparisons.
7. Why do LIC share prices go up or down if they are closed funds?
Share prices in an LIC reflect changes in the underlying value of the company, which itself is based around the value of the investments held within it. In addition, the market is also valuing the managers' ability to generate performance. This recognises issues such as costs and expenses to operate the company, tax paid/payable, franking credits, and the likelihood of future capital actions the company may take.
Because most LICs disclose their NTA only once a month, the market can trade blindly as to how the portfolio is performing through the month, hence the share price can over-shoot or under-shoot the actual portfolio performance. LICs are increasingly providing information about portfolio holdings through these NTA statements, to enable investors to better measure the effect of market events on the portfolio during the month. (Noting of course that the manager is buying and selling shares during the month).
8. Why do LICs trade at a discount to their NTA?
Discounts can exist for structural and behavioural reasons. Structural reasons can be attributed to historical capital activities of a company, such as issuing new shares at a discount to its share price; behavioural may simply reflect that more investors are selling a company's shares than are buying them. Perhaps there is negative market sentiment, or concerns over how the company is run. Structures evolve over time and investor behaviour changes through investment cycles.
Discounts can also be a result of liquidity concerns. If an investor looking to buy has concerns over the ability to sell the holdings in the future, it will effect how many they buy now and the price they will offer. Sometimes discounts exist for no other reason than many people having been conditioned by the statement "LICs trade at a discount". This will change.
Notwithstanding how a company arrived at a discount, investors should focus more on how it will perform in the future. Accordingly, where they identify a suitable investment and they find they can secure $1 worth of assets for, say, 85 cents (a discount of 15 per cent), they should regard the discount as an added potential benefit.
LICs have matured and should pass more of their underlying portfolio performance through into their NTA. The reasons include that they are increasingly issuing statements that they do not foresee the need to raise additional capital and the options embedded at listing have cleared. Larger company fund size provides scale-related benefits and as a percentage, fixed costs have less impact on performance.
In addition, the relatively new dividend legislation provides a degree of income certainty, and the increased profile LICs are receiving through active sales people and inclusion on financial advisers' approved-fund lists, all augers well for the future of LICs.
9. Should I buy an LIC just because it is trading at a discount?
No. You should invest in a company based upon your investment needs and the expectations of returns it will generate over the coming years, being mindful of the composition of those returns.
Focusing on discounts is hazardous and can be misleading, as is shown in the following hypothetical example.
|12 months||Portfolio performance||NTA||Share price performance||Discount to NTA (approximate)|
Hypothetical example, all numbers approximate to illustrate point
Clearly the better-performing company was BCD but if you just looked at the discount then company XYZ appears to be more successful, even though it clearly was not. Although past performance is no promise of future performance, over a long enough time it does provide an indication of a manager's actual ability, which is an important consideration to recognise.
Although a discount could be regarded as value that might be realised in the future, investors need to remain mindful that other investors may not value the company the same and any discount may even grow larger.
In conclusion, LICs can be a cost-effective way to access some outstanding fund managers and may be an appropriate vehicle to consider when investing in the market. A little research can yield substantial information you can use to identify potentially good investment opportunities.
About the author
Boyd Peters is national distribution manager at Contango MicroCap (ASX Code: CTN), a listed investment company that specialises in micro-cap investing.
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