Behind the LIC boom

Photo of Will Spraggett, Seed Partnerships By Will Spraggett, Seed Partnerships

min read

Listed Investment Company market breaks 100 listings on ASX.

The Listed Investment Company (LIC) sector has been one of the great success stories of the Australian Securities Exchange (ASX) over the past decade.

Although LICs have been trading on ASX for nearly 100 years, it is only relatively recently that a broader range of investors have capitalised on the opportunities offered by the sector, driven by changes in regulation, demographics and market conditions.

This has unleashed a new focus from asset managers and driven an evolution in shareholder-friendly product structure that Seed Partnerships believes will drive continued strong growth.
A LIC is an ASX-listed company established to invest in a portfolio of securities, managed by a fund manager. It raises a fixed amount of capital through an initial public offering (IPO) and new capital can only be raised through a corporate issue. Shares in LICs are traded on ASX like any other listed share.

There are three key differences between a LIC and a managed fund. A LIC is a company, its assets are held in a closed pool, and it is traded via ASX. Generally, managed funds are held in a unit trust, are open-ended structures and accessed through platforms.

Positive investor outcomes

The LIC structure supports some positive investor outcomes:

  • The payment of dividends is at the discretion of the LIC’s board. This gives a 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 and performance are not continually diluted by new capital entering the vehicle.
  • The structure does not support the outflow of the underlying capital. This means investor redemptions do not create a tax event for shareholders who remain in the company, impairing income.
  • The vehicle is a taxable entity. This focuses the manager on after-tax outcomes, particularly the generation of fully franked dividends.

Trade is facilitated on ASX and existing units are bought and sold, not created and redeemed. This means that a LIC may trade at a premium or a discount to its net tangible assets (NTA).

How a LIC trades in the secondary market will depend on several variables, including market capitalisation, investment performance, sustainable income, market engagement, and scarcity/relevance of the mandate.

Interestingly, the market at present is trading at a 0.8 per cent premium to its NTA on a market-weighted basis. On an equally weighted basis, the premium falls to a 2.8 per cent discount, highlighting that it is the volume of smaller LICs that are accounting for the discount, as illustrated below.

This is probably partly because of overhead costs of managing a company (largely fixed and diluted with size) excessively effecting the return, which is also a factor that an investor needs to evaluate in lower-return products.

Figure 1: LIC premium or discount to pre-tax NTA

Spraggett LIC capitalisation chart

Source: Seed Partnerships

Market capitalisation passes $33 billion
The capitalisation of the LIC market has been trending strongly, growing at 16.4 per cent per annum over the past five years to $33.1 billion at 30 June 2017. The number of LICs listed on ASX has also seen a strong and steady upward trend, rising from 52 in June 2012 to 102 now, and topping the century in June.

Despite this, the market capitalisation of the LIC sector is concentrated, with the bulk of funds under management (FUM) residing with the larger vehicles. There are 46 LICs with a market capitalisation above $100 million in FUM, managing $30.8 billion. This compares to the 56 LICs with a market capitalisation below $100 million in FUM, managing $2.2 billion.

The growth rate of LICs has been substantially higher than that of managed funds and there are several tangible reasons for this growth.

First, the Future of Financial Advice (FoFA) legislation in 2014 had a profound effect on the financial services market. It has driven increasing interest from financial advisers that are looking for alternative methods of accessing professionally managed portfolios. As a result, LICs have had a significant uplift in profile as investment managers, financial advisers and investors have increasingly used them.

Second, investors’ search for yield has put LICs front and centre. LICs are structured as a company and therefore the company directors determine dividend policy. This structural advantage over unit trusts has allowed LICs to position themselves as an attractive value proposition to Self-Managed Superannuation Fund (SMSF) investors chasing yield.

SMSFs are a valuable investor base to cater for, as they now account for 32 per cent of all superannuation assets in Australia and are growing.

Improved adviser and investor engagement

Other industry factors that have been supporting growth (LIC IPOs have raised $4.5 billion in the past five years) are:

  • the increased depth and breadth of products,
  • increased quality of managers, and
  • improved adviser and investor engagement.

There is also a potential evolution underway in the structure of LICs. Most notably, VGI Partners will be the first LIC to come to market that will reimburse the company for the issue costs associated with its IPO (day one NTA issued at par) and seek to absorb the vast majority of the ongoing operating costs of the company.

This type of structure is an interesting and positive development and we anticipate it is likely to drive further interest and larger capital raisings that are likely to tip through $500 million plus.

The LIC market remains largely dominated by domestic equity focused vehicles, which account for 83 per cent of the marketplace. Global equity product accounts for only 15 per cent of the LIC market, compared to the 33 per cent market share they hold in ETF products.

We anticipate growth will occur away from large-capitalisation domestic equity products and into those areas that are well under-represented. Global equity focused products are likely to be a key beneficiary and an increase in both the size and style of offering is likely. We also expect growth in more index-unaware products and those that offer a high and sustainable income.

Although it has been a strong period of growth for the LIC sector, we believe there are several drivers now in place that may see it accelerate for the next five years and beyond.

About the author

William Spraggett is a founding partner of Seed Partnerships, a specialist corporate advisory business that specialises in Listing Investment Companies.

From ASX

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

ASIC’s MoneySmart website has an article on how to invest in LICs.

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