One of the major trends in Australia over the last two years has been the resurgence of the listed investment company (LIC), writes NAOS Asset Management’s Sebastian Evans.
In the current low-interest rate environment the LIC has emerged as something of a ‘white knight’.
LICs work well for SMSFs and other individual investors who are tired of managing their own stocks and funds or would like expert exposure to a different segment of the market.
This is because of a LIC’s ability to pay a fully franked dividend stream, the fact LICs can be easily bought and sold on the stock exchange and because LICSs are now being offered by some of Australia’s most established fund managers.
Yet despite the LICs increasing popularity, investors should conduct due diligence before investing to help ensure the LIC they have chosen offers something truly different.
The last thing you want is an index-hugging LIC that charges excessive fees.
The Morningstar January 2015 LIC report indicates there are currently 74 LICs active in the market covering Australian equities, absolute return funds, international shares, private equity and specialist funds.
The number of LICs covered in the report is up from 62 in January 2014.
Fairfax reports the funds under management by LICs as $27.7 billion – a 15 per cent rise to the end of February 2015.
And while there is already a queue of LIC IPO hopefuls in 2015, in 2014 alone LICs are said to have raised around $1.5 billion.
This makes LICs one of the fastest-growing sectors in the funds management space.
Perpetual recently raised $250 million via its recent LIC IPO – placing it as the most abundant and bullish capital raising since the 2007 global financial crisis.
Perennial are currently hopeful of raising up to $160 million and Magellan's flagship fund expects to raise $143 million.
LICs are becoming big business
Financial advisers are urging market-savvy investors to use LICs to achieve diversification and to increase income via attractive dividends (much of which is fully franked).
LICs also appeal directly to the $568 billion in super funds, providing investors with a fantastic and often more tax-efficient way to achieve diversification as an alternative to managed funds.
This has been driven by the increase in Australians managing their own super.
Reports indicate there are now one million Australians managing their own retirement funds – up from 790,000 four-and-a-half years ago.
LICs are becoming somewhat of a darling in the eyes of SMSF investors, opening up new sectors to them.
For example, investing in a LIC specialising in global markets can extend your portfolio via an experienced fund manager.
LICs are also much easier to enter and exit – you simply buy and sell them on the ASX as you would any other stock.
Research from Investment Trends’ 2014 Advice and Product Needs survey of more than 10,000 financial planners reveals as at October 2014 there were 134,000 new LIC investors, with 40,000 investors saying they would start using LICs in the next 12 months.
The report found the motivating factor to LIC investment was diversification, followed by good long-term performance, suitability as a long-term asset and gaining access to different investment strategies.
Getting value for money
For first-time LIC investors, understanding the net tangible asset (NTA) of a LIC is paramount.
The NTA of a LIC will mean it trades at either a discount or a premium to what is displayed on the stock exchange.
You need to be wary of this as some funds pay for the costs and fees involved in establishing a LIC and incorporate this into the LIC’s pricing, meaning the fund trades below its asking price.
However some LICs incur costs making their NTA equal to the listed price.
Being alert to the NTA means you can make an informed decision about whether to invest or not, taking into consideration a LIC’s past performance, projected dividends and investment universe.
Before jumping in to invest in a LIC, there are some ground rules you can follow to help ensure that out of the 74 active LICs in Australia, your investment will add value to your portfolio.
The first is to investigate the LIC extensively, and think about it in terms of how it can add value to your existing stock portfolio.
If you have already heavily invested in large caps, perhaps a LIC with exposure to emerging companies would be beneficial.
Request a meeting with the fund manager or investment team to understand the philosophy and strategy of the LIC.
I would suggest looking into the past performance of the fund manager, and any other funds they manage that the LIC might ‘mirror’ in investment strategy, as well as looking at historic returns and making sure they are above market and not too volatile.
Also look at whether the directors and managers of the fund have a significant interest in the LIC – if they have put their money where their mouth is, it indicates their interests are aligned to those of their fellow shareholder.
Investigate how dividends are paid, whether it is per annum plus franking and at what rate. Investors should look out for dividends being paid out of profits and not capital returns.
Many LICs also have cash components, and you should check whether the LIC has the ability to preserve capital through higher cash holdings and or short selling.
In the current market significant levels of cash can be held to ease market volatility.
The onslaught of LICs in Australia in the past two years is testament alone to the appeal of this worthy investment vehicle.
Yet as with any investment, caution should be used to ensure your LIC investment is rewarding – and profitable.
Sebastian Evans is the chief investment officer and managing director of LIC provider NAOS Asset Management.
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