Listed Investment Companies

Listed Investment companies, or LICs, are listed companies that trade on the Australian Securities Exchange (ASX) and give investors exposure to a wide range of local and international asset classes.

Their objectives are two-fold: to achieve a high level of capital growth by outperforming the market sectors they invest in and to provide investors with a regular income stream though fully franked dividends.

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Types of LICs

The huge growth in the LIC sector means you have unprecedented choice when it comes to which sector you put your money into.

For example, Contango MicroCap, WAM Capital, and Acorn Capital specialise in small and microcap shares, BKI Investment in large ASX stocks, Global Mining Investments in mining stocks, and Platinum Capital in international shares. The

largest two LICs on the ASX are the Australian Foundation Investment Company (AFIC) and Argo Investments (ARG).

Both of these companies have billion-dollar portfolios and invest primarily in ASX200 listed companies. The returns on these companies over the past decade have been mainly in line with ASX indices.

Higher Yields

The Listed Investment Company sector is one of the ASX’s success stories of the past three years – the number of LICs has jumped from 51 to 87, while market capitalisation has surged by over 40 percent to almost $30 billion.

Part of the reason for this is that investors are waking up to the benefits LICs offer. You get a ready-made portfolio in a specific market sector managed by experts in that field. This means you can diversify without having to do the hard work researching individual companies yourself – the LIC can find the companies with the most compelling growth stories for you.

The 2013 Future of Financial Advice (FOFA) reforms helped raised the profile of LICs and their advantages. LIC valuations used to focus on their discount or premium to Net Tangible Assets (NTA), but changes to the tax regime mean LICs can now pay fully franked dividends to investors more effectively. Additionally, most LICs have firm dividend policies that return all profits to shareholders, usually in payments made twice a year.

With interest rates currently at historical lows, the biggest yield hunters are SMSFs, who account for 32 percent of all Australia’s superannuation assets. SMSF appetite for dividends is likely to keep growing and while the current interest rate cycle continues, LICs are becoming an increasingly attractive value proposition.

What is the NTA of a LIC?

The Net Tangible Asset of a Listed Investment Company is one important factor in its overall value proposition. NTA is calculated as the total assets of a company (not including intangible assets such as goodwill), minus all liabilities.

Listed companies may trade at multiples of their NTA during a boom in a sector, or at a discount to NTA, for a number of reasons. Sometimes it’s simply because the company has not received the right publicity and the market isn’t yet aware of its value. In a lot of instances, especially for small-cap companies developing products and services in sectors like information technology, renewable energy, and biotechnology, long-term growth prospects and future financial viability are far more important than NTA.

Listed Investment Companies trade on the ASX in the same way that

listed companies do, so investing in an LIC that deals only in listed shares is effectively like buying a share portfolio in one hit. The NTA should then, in theory, mirror the value of the shares held in the LIC portfolio at any given time. LICs usually trade near their pre-tax NTA. However, successful LICs usually outperform their market sector so looking at NTA in isolation is never a good indication of a Listed Investment Company’s overall value.

Several factors determine real value Like any small cap or ASX200 company, an LIC’s long-term financial performance, its dividend yields, the ability to pay future dividends and improve on its solid performance are all important factors. So is the managers’ ability to trade successfully through market cycles.

LICs have other advantages that may not be reflected in their NTA. Listed Investment Companies can return

profits to shareholders through dividends – usually twice a year – which means that their Net Tangible Asset base may not grow even when they outperform their sectors.

LICs also have a close-ended structure where investors buy and sell shares but large amounts of money generally don’t flow out of the company. LICs receive ranking credits from tax paid on company profit, as well as from franked dividends of portfolio companies. This means that, as an LIC investor, you can receive a steady income from fully franked dividends.

Paying fully franked dividends makes LICs hugely popular in the booming self-managed super fund (SMSF) market, where good investment income in a period of prolonged low-interest rates has been hard to find.

As an investor, long term performance of an LIC and its dividend yields should be looked at alongside the NTA.

Active Versus Passive Management

As a shareholder, you can choose between two main strategies: active portfolio management and passive management. These approaches differ greatly in how a fund manager selects investments. Active managers are constantly trying to outperform the market’s index benchmarks, while passive managers are basically trying to replicate the index performance, for example the performance of the S&P/ASX200 Index.

The oldest and largest LICs listed on the ASX – Australian Foundation Investment Company (AFI) and Argo Investment (ARG) – can be seen as employing a passive investment strategy.

Meanwhile the vast majority of LICs employ an active management strategy. LIC managers have a deep understanding of their sectors, such as small caps, and are passionate about outperforming their indices. Active LICs actively scour the market for the next industry game changer, whereas passive managers have no chance of finding these hidden gems. The small-cap sector of the ASX comprises more than 1800 companies yet it accounts for a tiny 3 per cent of total market capitalisation. Much of this market is barely covered by mainstream analysts and the media. Yet this is exactly where active small cap LIC managers can unearth hidden gems.

Active LIC managers also strive for increased profits to maximise returns to shareholders through higher dividend payments. With the benefit of actively selecting stocks Listed Investment Companies can offer investors fully franked dividends, usually twice a year. Self-managed super funds (SMSFs), who rely on a steady income stream from their investments benefit from these LIC dividends.

The History of LICs in Australia

The Australian listed investment company (LIC) sector has exploded over the past three years with the number of LICs jumping from 51 to 87, while market capitalisation has surged by over 40 percent to nearly $30 billion.

The largest Australian LIC started in 1928 as Were’s Investment Trust, adopting its current name of Australian Foundation Investment Company (AFIC) in 1938. It listed on the stock market in 1962 and now has a market cap of more than $6 billion. The second-largest LIC, Argo Investments, was established in 1946 and listed on the ASX in 1950. It currently has a market cap of $4.3 billion. Both of these companies invest primarily in ASX200 listed entities and thei

returns over the past decade have generally mirrored those of ASX benchmarks.

The number and scope of LICs has changed considerably over the past decade as new investment companies continue to list on the ASX in areas as diverse as small caps, international shares, mining, technology, and unlisted equities, due in large part to two fundamental changes to the financial services landscape.

The first of these was in 2010 when the Corporations Act was changed, allowing companies to pay dividends as long as they are solvent. Previously they were required to have an accounting profit on their books for a financial year. This has been

of particular benefit to LICs, which have since gained more flexibility in paying a regular stream of fully franked dividends to shareholders.

The second significant structural change in the financial sector was the 2013 Future of Financial Advice (FOFA) legislation, which banned commissions to financial planners from providers of managed funds on new allocations.

This meant financial planners, who previously had a significant financial interest in recommending managed funds, started recommending LICs to clients, playing a large part in the growth of LICs over the past few years. Since 2013, the wealth dvisory industry has advised a record number of clients, especially those with self-managed super funds, into investing in LICs.

What exposure do I get from buying LIC shares?

If you’re looking to invest in a new sector of the ASX but you don’t have a large amount of money or hundreds of hours of time to spend researching an enormous number of individual shares, then a Listed Investment Company (LIC) may be the ideal entry point for you.

LICs trade on the Australian Securities Exchange (ASX) in the same way that listed companies do. Investors buy and sell into the market without the limitations put on them by unlisted managed funds that often trade only once a day.

The LIC sector has experienced a serious growth spurt over the past three years, with market capitalisation surging by over 40 per cent in that period to almost $30 billion.

This growth means you now have an unprecedented amount of choice when it comes to where you put your money. There are currently 87 LICs trading on the ASX, covering a wide range of sectors from ASX200 blue-chip stocks to small caps and international shares.

Investing in an LIC gives you exposure to a whole new market sector with a ready-made portfolio of shares hand picked to deliver a combination of growth and dividends. The best LICs are run by specialists who have built their reputations over many years and have a proven track record of outperforming their benchmarks. As an investor, you gain instant exposure to a market sector through a ready-made portfolio of shares hand-picked by experts.

The largest LICs focus on ASX listed blue-chips and have multibillion-dollar market caps. These include: Australian Foundation Investment Company (AFIC), ($6.8 billion), Argo Investments ($5.3 billion), Milton Corporation ($3 billion) and Djerriwarrh Investments ($1 billion).

Others specialise in small-cap listed companies: Glennon Small Companies, Contango MicroCap, WAM Capital, and Acorn Capital. If on the other hand, you want exposure to foreign shares, you can invest in an LIC that deals exclusively with markets in Asia, Europe, or the United States. LICs that specialise in international shares include AMP Capital China Growth Fund, Magellan Flagship Fund, Platinum Capital Limited, and Templeton Global Growth Fund, all of which are in the $300 million–$500 million market cap range.

There are also LICs that specialise in diversified market areas such as fixed interest, private equity and technology. More than 30 LICs have listed on the ASX since 2012, several in obscure asset classes. Some examples of these include Bailador (unlisted technology), Blue Sky Alternatives (alternative markets), and IPE Limited (unlisted equities).

As the LIC sector continues to expand, investors will doubtlessly be able to gain exposure to an expanded range of asset classes and international markets.

How Transparent are LICs?

Listed Investment Companies (LICs) provide investors with a diversified portfolio of assets in a specific market segment
professionally managed by experts in their fields. These asset classes include Australian and international shares, private equity, fixed income securities, and property, while some LICs offer combinations of the above sectors.

LICs are listed on the Australian Securities Exchange (ASX) and investing in an LIC is exactly like buying shares. They are bought and sold on-market in exactly the same manner as ordinary listed

shares. Investors have full control of their investment and can trade in and out of a fund according to their investment objectives.

As ASX entities, listed investment companies are bound by the rules governing all ASX companies and their corporate governance and reporting requirements, which makes them highly transparent investment vehicles.

Regular up-to-date pricing also means that LIC unit holders can see the value of their holdings in real time. This level of transparency gives LICs a distinct advantage over

unlisted managed funds, which are usually traded only once a day, often with a substantial time lag between the issuing of a buy or sell trade and its execution.

At the end of the day, many clients, especially self-managed super funds (SMSF) are looking for a diversified portfolio that exhibits good performance, attractive fee structures, and pays regular dividends. This level of transparency in holdings, trading and governance, in conjunction with the regularity of dividend income, make LICs an ideal investment vehicle for SMSFs, or anyone looking for stability and a regular income stream from a listed fund.

Benefits of LICs over ETFs

Listed investment companies (LICs) and exchange traded funds (ETFs) are both listed investments trading on the Australian Securities Exchange (ASX) that provide exposure to diversified portfolios of specific market sectors.

The listed structure means ETFs and LICs offer fast and easy execution: ETFs and LICs trade like stocks during market hours meaning you can buy and sell your share at any time with little lag, unlike managed funds, which usually are traded only once a day. As ASX-listed entities, LICs and ETFs also have a high level of transparency, disclosing the holdings of their portfolios regularly.

However, there are important distinctions between these two investment vehicles and understanding their features and the investment strategy is crucial to gauging which one is more appropriate for you.

ETFs are designed to create a portfolio of shares, bonds, or commodities that mirror an index. Like LICs, they can be linked to the entire market or a particular market sector. However, ETFs usually track an index, not outperform it.

LICs, on the other hand, use active investment strategies and their managers are dedicated to outperforming the index of the sector in which they operate. That means that LICs that operate in sectors such as small caps are constantly looking for companies with the most compelling growth prospects across a range of industries to propel their portfolios.

ETFs are also open-ended. Investors can trade ETF units with each other on the exchange, but when there is an excess of supply or demand, market-maker steps in to create or redeem units. That means an ETF should always trade close to the underlying net asset value (NAV) of its holdings. Investors should rarely see a substantial premium or discount in a well-managed ETF, and if there is a gap, it should close quickly.

LICs on the other hand are closed-ended. The number of shares is fixed, so when there is an imbalance between demand and supply, the share price may trade at a premium or discount to the net tangible asset of the shares in the fund.

ETFs and managed funds pay no tax themselves. They are tax-transparent and must pass on any income (dividends or realised gains) within the financial year it is earned.

By contrast, LICs are companies, so they can choose to retain earnings and reinvest them, or pay out earnings as dividends. LICs pay company tax on their earnings and when they do elect to pass through dividend income, investors may receive franked dividends.

his allows LICs to pay investors fully franked dividends, whereas ETFs only pay investors dividends from the underlying investment companies (flow-through dividends).

The Growth of the Australian LIC

The small cap sector of the Australian Securities Exchange (ASX) consists of more than 1800 listed companies but comprises only 3 per cent of total market capitalisation.

Yet small caps offer a wealth of opportunities to the savvy investor and listed investment companies (LICs) that specialise in the sector are ideally placed to take advantage of this segments of

the market. There are several ASX- listed LICs currently specialising in the small cap sector. These include Glennon Small Companies, Contango MicroCap, WAM Capital, and Acorn Capital.

There’s no shortage of under- researched, and undervalued small cap ASX companies. Many of these companies just aren’t on the radar of the mainstream media and the broking community.

However, there are also plenty of companies that should be avoided, and finding the stocks that best fit your investment objectives can be an extremely time consuming and painstaking process.

Active small cap LIC managers are always on the lookout for companies flying under the radar and small cap LIC managers are ideally placed to offer investors exposure to small caps.