LICs and the hunt for high yield

Photo of Will Spraggett By Will Spraggett

min read

Cash rates in Australia have plummeted to unforeseen levels, forcing many investors to move away from cash and fixed income in the chase for yield. Consequently, an increasing number of investors are allocating a higher proportion of their portfolio to equities.

Investors generally gain this exposure by investing directly into listed equities or via a managed fund. However, very few usually consider the merits of using a Listed Investment Company (LIC), particularly when income is a key objective.

Aesthetically, LICs are similar to a managed fund in that they offer investors access to a professionally managed investment vehicle. The major differences are that the assets are held within a company as distinct from a unit trust, are closed-ended vehicles as distinct from open-ended structures, and they are listed and traded on ASX.

This structure has some interesting ramifications, particularly for those investors chasing after-tax yield:

  • The payment of dividends is at the discretion of the LIC’s board. This gives an LIC some leeway to control distributions of dividends through the cycle.
  • There is no taxation impediment for retaining profits. This allows the board to retain profits and maintain distributions through periods of weak performance.
  • The vehicle is not exposed to daily capital inflows. This ensures that dividends are not continually diluted by new capital coming into the vehicle.
  • The structure does not support the outflow of the underlying capital. This means investor redemptions do not create a tax event for investors who remain in the fund, impairing effective income.
  • The vehicle is a taxable entity. This focuses the manager on after-tax outcomes, particularly the generation of fully franked dividends.

Not withstanding any LIC quirks, we believe LICs provide an interesting structure for investors focused on fully franked yield, and offer a highly credible alternative to direct investment, or indeed, unit trusts.

Diversity of LIC choice on ASX

LICs have an enticingly wide breadth of products offering a number of credible yield opportunities that span 78 LICs and account for $28.3 billion in market capitalisation. This includes domestic equity (76 per cent of funds under management), international equity (9 per cent) and alternatives (15 per cent), and myriad permutations that sit within these definitions.

The largest proportion of the LIC industry is focused on large-capitalisation equities. They tend to be low-cost operators with indirect cost ratios of less than 20 basis points (management fees). This is notably cheaper than most Exchange Trade Funds. Higher-profile stalwarts include AFIC, Argo Investments, BKI Investment, Milton Investments and Whitefield.

These investment companies have had an extraordinarily long track record of serving investors and have offered a trailing grossed-up dividend yield of 5.9 to 6.6 per cent. This compares favourably to the All Ordinaries index, which offered a 5.1 per cent grossed-up yield on a similar basis.

LICs and small-cap stocks

LICs focused on mid-to-small capitalisation tend to operate in less-efficient areas of the market and canny operators have been able to deliver very strong returns. Carlton Investments, Mirrabooka Investments and WAM Capital have operated in the space for decades. These incumbents offered a wider dispersion of grossed-up dividend yields of 5 to 9.5 per cent.

International LICs are perhaps another area of interest, given they are able to pay fully franked dividends on the basis that they have profit reserves and franking credits available. However, this area has been slightly more problematic in recent years as passive currency exposure has weighed on the performance of a number of these LICs and, in turn, the generation of profit reserves and franking.

Despite this, Platinum Capital and the lesser-known Global Value Fund delivered healthy 7.8 per cent and 5.9 per cent grossed-up yields, respectively.

The alternative space has offered up myriad interesting products. Perhaps the best known is Djerriwarrh Investments, an enhanced yield fund that delivered a 9.1 per cent grossed-up return by writing call options over its investments.

The long/short area is perhaps another that is interesting on the yield front, with Cadence Capital and Australian Leaders Fund, which had yields in excess of 7 per cent and attractive total market returns.

Investors in LICs need to be aware that dividend yields are only part of the equation, and need to be taken in context of a total portfolio return. Also note that we have used trailing grossed-up yields, and clearly this is no guarantee of what a manager will pay in the future.

We acknowledge that LICs are not without quirks and admit that an LIC may trade at a discount or premium to NTA. Unit trusts also have their flaws, which may be less visible to the uninitiated but, we would argue, more difficult to manage than a premium or discount to NTA.

We do not seek to lambast one structure over the other, but we firmly believe that LICs offer a highly credible alternative, particularly for those investors who are increasingly yield hungry.

About the author

William Spraggett is a founding partner of Seed Partnerships, a specialist corporate advisory business that specialises in Listing Investment Companies. Seed Partnerships helped launch Future Generation Global Investment Company (ASX Code: FGG), an LIC with dual objectives of providing its shareholders with a diversified exposure to global fund managers while also seeking to change the lives of young Australian affected by mental illness.

From ASX

Listed Investment companies and trusts provides information the features, benefits and risks of ASX-listed LICs.

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