Listed Investment Companies, or LICs, are companies whose business is to invest. Unlike Woolworths, NAB or BHP who each operate supermarkets, banks or mines respectively, an LIC’s business is to invest in companies or trusts according to its investment philosophy. The first such vehicle was listed in Britain as a listed investment trust in 1868. The aim of this trust was to provide:
“investor(s) of moderate means the same advantages as the large capitalist in diminishing the risk of investing in foreign and colonial government stocks, [by] spreading the investment over a number of different stocks” (Source: Wilson Asset Management).
For various reasons, modern Australian listed investment vehicles are usually structured as companies. Hence the term, ‘listed investment companies’. They are called ‘listed’ investment companies because they are listed on the ASX and shares of the company can be bought and sold just like any other company traded on the ASX.
The oldest Australian LIC is Whitefield Ltd which was incorporated in 1923. Australia’s largest LIC is Australian Foundation Investment Company (AFIC) and has a market capitalisation of approximately $7.5 billion. It started life in 1928 as as Were’s Investment Trust Ltd and changed its name to AFIC in 1938.
LICs: The Basics
Listed Investment Companies are closed-end structures. This means that there is a fixed number of shares (excluding rights issues, capital raisings etc.). Like all companies on the ASX, they must be first be listed via an IPO (Initial Public Offering). This involves a fixed number of shares being made available to be purchased by the public. These companies then invest in companies and trusts according to their investment philosophy. The only time that the number of shares in an LIC changes is when additional shares are issued, for example when there is a rights issue, capital raising or when a dividend re-investment plan is active (this is where an investor receives additional shares in the company in lieu of cash).
Contrast this with a trust where new units are created every time a investor adds money to the trust (as is the case with an Exchange Traded Fund (ETF)). For example, when you purchase units in the Vanguard Australian Shares Index ETF (ASX: VAS) additional units in the trust are created in response to investor demand. More demand means more units are created. Conversely, less demand means less units are created.
LIC’s are taxed as a company whereas ETFs are taxed as a trust. LICs can also pay a dividend which includes a LIC Capital Gain Amount meaning that the shareholder will be entitled to a tax deduction. The LIC will always say what proportion of the dividend is a LIC Capital Gain Amount (if any). The different tax treatment of LICs versus ETFs is an important consideration for potential investors since extra tax can reduce an investor’s after tax return. Talk to you tax agent about this.
Both LICs and ETFs are investment vehicles which hold a portfolio of investments. ETFs generally track an index. This could be anything from the ASX300 index – consisting of the 300 largest companies on the ASX – or something more niche such as the ROBO Global Robotics and Automation Index – consisting of companies around the globe that operate in one of twelve subsectors relating to robotics and artificial intelligence. LICs on the other hand are usually index agnostic, preferring instead to invest according to a particular investment philosophy. For example, WAM Capital has the following investment objectives:
- deliver investors a rising stream of fully franked dividends;
- provide capital growth; and
- preserve capital of the Company.
The investment objective can be as vague or specific as the fund manager and its investors like. LICs generally aim to outperform an index whereas ETFs aim to track one.
LICs and Net Tangible Assets (NTA)
An LIC’s NTA is the total value of the assets owned by the trust less any liabilities. Since LICs are closed end structures it is possible for them to trade at premiums and discounts to NTA. For example, if a LIC’s NTA per share was $1.00 and it was being traded on the ASX for $0.95, the LIC would be trading at a 5% discount to NTA. If it was trading at $1.10 then it would be trading at a 10% premium.
When discussing LIC premiums and discounts to NTA you will often hear two different types of NTA being discussed: pre-tax NTA and post-tax NTA. Pre-tax NTA refers to the company’s NTA prior to deducing taxes such as capital gains taxes which would be payable if the LIC were to sell all its investments. Post-tax NTA deducts these taxes when calculating NTA. For buy and hold type LICs pre-tax NTA is the most applicable while LICs who have high investment turnover would best be judged using post-tax NTA.
LICs can trade at a premium or discount to NTA for various reasons including: performance, investor sentiment towards the LIC, fees, popularity of the LIC and its managers, liquidity, tax policy and more. For example, Whitefield Ltd consistently trades at a 5-10% discount to NTA primarily due to lack of liquidity, lack of popularity and fees.
Different Types of LICs
There are many different types of LICs. I like to divide these LICs into two different categories: 1) the conservative LICS and 2) all the rest!
The conservative LICs are typically older than all the other LICs and have a very conservative investment philosophy. These LICs include:
- Australian Foundation Investment Company Limited (ASX: AFI)
- Argo Investments Limited (ASX: ARG)
- Milton Corporation Limited (ASX: MLT)
- BKI Investment Company Limited (ASX: BKI)
- Australian United Investment Company Limited (ASX: AUI)
- Diversified United Investment Limited (ASX: DUI)
- Whitefield Limited (ASX: WHF)
AFI is the largest LIC on the ASX. What all these LICs have in common is that they have a conservative income focussed investment philosophy with the aim of providing an investor with a diversified exposure to Australian equities (and sometimes other countries) which are expected to provide the investor with capital appreciation and dividend growth in the medium to long term.
All the ‘other LICs’ are a real mixed bag. This category includes the LICs which are part of the ‘Wilson stable’, which are probably some of the more well-known LICs outside of the above-mentioned conservative LICs. These LICs are all managed by a company called Wilson Asset Management, which was established in 1997 by Geoff Wilson. The Wilson stable consists of six LICs:
- WAM Capital (ASX: WAM)
- WAM Leaders (ASX: WLE)
- WAM Global (ASX: WGB)
- WAM Research (ASX: WAX)
- WAM Microcap (ASX: WMI)
- WAM Active (ASX: WAA)
There are many other types of LICs which focus on everything from investing in private equity, high conviction Australian equities, technology companies and Asian companies – just to name a few. ETFWatch.com.au is a great website which provides information on ASX-listed LICs and ETFs.
Both LICs and ETFs charge fees. These fees are taken out of the investment revenue generated thus it is an important consideration since it can impact investment returns. For LICs these fees are typically broken into two types: a management fee and a performance fee. None of the conservative LICs charge a performance fee. Performance fees are charged once a particular benchmark of investment performance has been met, such as if the fund has outperformed a particular index. Management fees (often called the Management Expense Ratio or MER) are charged for day-to-day management of the LIC. This fee pays for the salary of the board members and other expenses involved in running an ASX listed company. For a conservative LIC such as Australian United Investment, this MER is just 0.10% with no performance fee; but for a high flyer such as WAM Capital the MER is 1.00% plus a 20% performance fee for the amount by which the fund has outperformed the All Ordinaries Accumulation Index. Thus, fees are an important consideration. For comparison, the Vanguard Australian Shares Index ETF has a MER of 0.10%.
LICs can be a great way for an investor to gain exposure to a diversified portfolio with minimal fees. An LIC is just a vehicle for holding investments, at the end of the day it is the managers of the LIC which determine how it will perform.