Listed Investment Companies have been under pressure in recent months, on average trading at their largest historic discount to their net tangible asset valuations through a combination of increasing supply and poor performance. In this article we look in detail at Listed Investment Companies.
What are Listed Investment Companies?
A Listed Investment Company is an actively managed fund wrapped up in a company structure that is listed on the ASX. Instead of selling or making widgets Listed Investment Companies invest in stocks and or other assets such as cash and bonds. Everything else is similar. They have boards, management, report financial accounts, pay company tax and franked dividends. The investor holds a share in a company that gives exposure to an investment portfolio (assets).
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Listed Investment Companies can also exist in a trust structure where a trustee essentially performs the same role as a board does in a company. These are known as Listed Investment Trusts (LITs) where investors hold units. The LIT pays no tax, so distributions are not franked. For the sake of simplicity, we will refer to both of these as Listed Investment Companies.
A Listed Investment Company is managed internally or by a third-party. Australian Foundation Investment (AFI) for example manages its investments itself, while Whitefield (WHT) has outsourced the management of its investments to White Funds.
The vast majority of Listed Investment Companies are focused on Australian or international equities using varying strategies, but there a few that invest other asset classes such as private companies, bonds, debt, property and infrastructure.
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Are Listed Investment Companies a good investment?
Listed Investment Companies are a good investment due to their rapid growth. Six years ago, there were 62 Listed Investment Companies with a total market capitalisation of $28.5bn. At the end of October 2019 there were 114 Listed Investment Companies representing a combined market capitalisation of $49.4bn.
What are the reasons for the rapid growth in Listed Investment Companies?
There are a number of reasons for the rapid growth of Listed Investment Companies which we outline below. However, they are primarily supply related, i.e to fund managers seeing advantages of running a Listed Investment Company in a competitive market.
1. Commissions incentivise advisor and brokers to sell Listed Investment Companies
Exemption to FOFA (financial advice) legislation in 2014 allowed advisors and brokers to receive commissions from fund managers for selling shares in Listed Investment Companies. Time will tell whether any clients were ‘sold’ any risky Listed Investment Companies not suited to their risk appetite.
2. Attraction of permanent Funds Under Management (FUM)
Listed Investment Companies provides locked in capital or Funds Under Management (FUM) for a fund manager, which provides the all valuable fee income. A unlisted fund manager has to manage liquidity risk from money flows – inflows from new contributions and outflows from redemptions. This adds another risk for these fund managers as they have to ensure they have sufficient liquidity to meet redemption requests.
3. Greater access to retail investors
Having a fund in a Listed Investment Company structure provides another distribution channel, the ASX, which is easily accessed by retail investors.
4. Countering threat from ETFs
There has been a shift in funds flow away from unlisted funds into lower cost alternatives such as index-linked exchange trade funds (ETFs). Setting up a Listed Investment Company allows a fund manager to provide an alternative to ETFs. They just have to justify their higher fees with superior performance, which is easier said than done.
Biggest ever Net Tangible Asset discount
Listed Investment Company shares have been trading at increasing discounts to their underlying value or what is referred to as their Net Tangible Asset (NTA) value. The average discount to pre-tax NTA at the end of September was about 8% compared to around 3% a year earlier. ASX Investors have been targeting certain Listed Investment Companies with the aim of narrowing the gap to profit.
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Listed Investment Companies buyer beware
Investing in a Listed Investment Companies is similar to making an investment in a managed fund but there are specific things to look out for:
1. Fit for purpose
Make sure the investment mandate of the Listed Investment Company is exactly what you are looking for and the risk profile matches yours.
2. Compare fees
Are you getting the best bang for your Listed Investment Company buck? See what else is out there. ETFs provide a relatively cheap and easy way to access different assets classes using passive (index tracking) and active strategies. The growth in ETFs has certainly given retail investors greater choice and is putting downward pressure on funds management fees. At the end October 2019 there were 204 ETFs on the ASX with a capitalisation of $128.8bn.
3. Sufficient liquidity
Ensure the shares in the Listed Investment Company have sufficient turnover so that you can get in and out of it without having to wear the cost of wide buy-sell spreads
4. Share price to NTA gap
The only way to redeem your investment in a Listed Investment Company is to sell on market. The performance in shareholders hand is determined by the share price and dividends received. However, a Listed Investment Company’s share price performance may vary from performance of the underlying investments. A Listed Investment Company with a history trading at a discount to its NTA means you will have difficulty in realising the value of that Listed Investment Company’s underlying investments. ETFs have market makers, which provide liquidity and ensure the share price is very close to the NTA.
4. Listed Investment Companies are closed-end funds
Regular investments/contributions can’t be made into it. Other than when it raises money through share purchase plans (SPPs) the only way to make additional investments is to buy more on market.
5. Approach new Listed Investment Companies IPOs with caution
Avoid a new Listed Investment Company if the initial investment funds raised will be reduced by fees paid to advisor and brokers.
Examples of interesting Listed Investment Companies
Hearts and minds investments (HM1)
HM1 is a high conviction, long only, concentrated Australian and global equities Listed Investment Company. It listed in November 2018 and invests in stock ideas from various fund managers. About 40% is invested in the recommendations of fund managers that present at the annual Sohn Hearts and Minds Investment Leaders Conference. The other 60% is invested in ideas of five core investment managers: Caledonia Investments, Copper Investors, Magellan Asset Management, Paradice Investment Management and Regal Funds Management. What makes HM1 unusual is that the fund managers forgo their fees and instead donate 1.5% of NTA per annum to Australia medical research organisations. n
Milton corporatio (MLT)
MLT is an internally managed old school Listed Investment Company that has been around as long as Argo Investments (ARG) and Australian Foundation (AFI), which were formed just after WW2. But Milton is one that doesn’t often come to mind when people talk about traditional Listed Investment Companies and has been around since 1938 and listing in 1958. It holds a portfolio of Blue Chip ASX stocks with a long-term focus on providing increasing fully franked dividends over time. Consequently, the portfolio has a relatively high weighting in bank stocks at just over 27% at last count. It is actively managed but largely employs a buy and hold strategy, hence stock turnover is low. It suits investors with a relatively low risk appetite looking for a steady dividend income stream
Wam microcap (WMI)
WMI is an externally managed Listed Investment Company that invests in ASX Small Cap Stocks with market capitalisations below $300m. It focuses on buying undervalued growth companies but also has a long-term objective of paying a stream of fully franked dividends. It is long only though it can short sell. WMI listed in June 2017 so does not have a long track record but the manager Wilson Asset Management has extensive experience in equity markets.