Treasurer Josh Frydenberg’s announcement last week that, from July 1, he would ban the payment of stamping fees on listed investment companies (LICs) and listed investment trusts was long overdue. The practice, which was wholly inconsistent with the principle of non-conflicted remuneration for advisers, saw some retail stockbrokers and financial planners being paid a commission, typically 1.0% to 1.5% of the investment amount, by the promoters of these investment vehicles.
Somewhat inexplicitly, the ban was not extended to hybrid securities, real estate investment trusts and listed infrastructure trusts.
So does this ban mean that LICs are dead in the water? On the one hand, it is going to make it harder for promoters (typically fund managers) to launch new issues because they will struggle to get the involvement of some financial planning groups. They will have to turn to other ways to motivate investors to part with their monies such as providing up-front incentives to invest (e.g. loyalty shares, discounts etc). The cost of the incentives will be paid by the promoters from their own monies, recouped by management fees over the next 10 to 15 years.
While this will be a boon for direct investors, who have arguably been subsidising the clients of financial planners, only the strongest investment managers will be in a position to offer up-front incentives. We may see some jumbo issues from the “brand” LIC managers, but overall, new issuance is likely to decline.
LICs do offer two important advantages over other structures. Firstly, because they are close-ended structures with a finite number of shares, the investment manager has a fixed pool of capital to invest. He/she doesn’t have to worry about inflows or outflows. Secondly, as companies, the Directors can deliver a smoother payment of income to their shareholders because the payment of dividends is discretionary. They can also offer dividend re-investment plans and share purchase plans.
The big disadvantage is that most LIC’s trade on the ASX at a premium or discount to their NTA (net tangible asset value). If you buy at a premium of 20%, you pay $1.20 for something that is really only worth $1.00. If you buy at a discount of 20%, you pay $0.80 for something that is worth $1.00.
In some cases, the discount or premium can be very material, as high as 25% to 30%. Moreover, most LICs are now trading at a discount to their NTA (about 85% by number of issues), with the average discount over 15%.
The alternative structure is the exchange traded fund or actively managed quoted fund (which is used by Magellan in MGE or for our Switzer Dividend Growth Fund – SWTZ). This employs an open-ended trust structure, supported by market makers on the ASX to provide liquidity. It grows in size (or contracts) depending on investors buying or selling on the ASX, with the job of the market maker to ensure that it trades very close to its underlying NTA. During the extreme market volatility in March/April, the market makers did a reasonable job to provide liquidity and overall, this structure looks set to be the one issuers embrace.
While quoted managed funds are set to be the go forward vehicle, there are still 111 LICs trading today on the ASX. Typically, poorer performing, smaller and less well marketed LICs tend to trade at a discount to their NTA, while LICS that are better performing, larger and put more effort into shareholder communications tend to trade at a premium. But it is not always the case.
Here are 3 LICs from different sectors to consider buying, and 3 to consider selling.
3 LICS to buy:
1. Australian equities – Future Generation Investment Company (FGX)
The Future Generation Investment Company (FGX) is a fund of funds, set up by the industry as a philanthropic measure to raise money for charities. While investors (shareholders) are charged a management fee of 1.0% pa, leading Australian fund managers donate their time to manage the monies and most service providers do so on a pro-bono basis. This allows the management fees to be donated to Australian children and ‘youth at risk’ charities.
As an investment, the $430m investment company has exceeded the performance of the S&P/ASX 200 over 1 year, 3 years, 5 years and since inception in 2014, with a lower volatility than the market. It accesses 20 different managers, who each have very specific mandates.
FGX is trading at a discount to its NTA. At 30 April, this discount was 15.1%. On Friday, it closed at $0.93, which we calculate is a discount of around 12.3% (our estimated NTA is $1.06).
2. Global infrastructure – Argo Listed Infrastructure (ALI)
Argo Global Infrastructure (ALI) provides exposure to an actively managed portfolio of globally listed infrastructure companies. Managed by NYSE listed Cohen and Steers who manage around US$70bn on behalf of institutional clients and sovereign wealth funds, about 38% of the fund is invested in electric, 16% in communications, 9% in toll roads and 7% railways. 57% of companies are domiciled in USA, with Europe next at 11%.
Performance has been satisfactory. It has outperformed the S&P/ASX 200 accumulation index quite convincingly (for example, 4.1% for the year to 30 April vs a 9.1% negative return for listed Australian shares), but against its benchmark, it is marginally behind. It is unhedged. Management fees for the $304m LIC are 1.2%.
On 30 April, ALI closed on the ASX at $2.14, a 9.3% discount to its NTA of $2.36. It provides a weekly NTA estimate and on 15 May, this was $2.31. A new NTA should be posted tomorrow (Tuesday).
3. International equities – WCM Global Growth Ltd (WQG)
For disclosure, I am a Non-Executive Director of WCM Global Growth (WQG). But notwithstanding that conflict, I still think this is a LIC you should consider.
This $237m LIC is managed by WCM Investment Management, a California based asset management firm specialising in active global and emerging market equities.
WQG comprises investments in about 30 global mid-market companies. They need to meet two key criteria: a rising competitive advantage (or expanding economic moat) and a corporate culture that supports the expansion of the moat. About 24% of the fund is in IT, 23% in health care and 14% in financials, with the Americas accounting for 76% of the companies.
Portfolio performance has been outstanding. It has outperformed over all periods, and since inception, it has delivered an annualised return to 30 April of 17.2% compared to the benchmark’s 9.8% pa.
The management fee is 1.25% plus a performance fee. It is unhedged.
On 30 April, WQG closed on the ASX at $1.18, a 13.6% discount to its NTA of $1.365. It provides a weekly NTA estimate and on 15 May, this was $1.41. A new NTA should be posted tomorrow (Tuesday). WQG closed on Friday at $1.26.
2 LICs to sell:
1. Australian equities – Australian Foundation Investment Company (AFI)
Australian Foundation Investment Company (AFI) is Australia’s largest listed investment company with a $6.7bn portfolio. It invests in a broad-based portfolio of shares and aims to provide shareholders with attractive investment returns through access to a growing stream of fully franked dividends and an enhancement of capital invested over the medium to long term.
Internally managed, the management cost of 0.13% pa is very low.
However, its performance largely mimics the benchmark indices, and, in this regard, it has underperformed over the last 5 years and 10 years. It has changed its benchmark to include the franking credit benefits, and over the last 12 months, it has done better as it has boosted its weighting in CSL and cut its exposure to the major banks.
At the end of April, it was trading at a premium of 4.7% to its pre-tax NTA of $5.54. It closed on Friday at $5.76, putting it on an estimated premium of 4.0%.
2. Australian equities – Argo Investments (ARG)
Australia’s second largest listed investment company, the $5.3bn Argo Investments is also trading at a premium to its NTA. Officially, a premium of 7.4% on 30 April and 5.9% on 15 May (to its credit, Argo is now reporting its NTA on a weekly basis). On Friday, it closed at $7.23, which puts it on an estimated premium of 5.7%.
Argo has now underperformed the benchmark ASX 200 Accumulation Index over the last 1 year, 3 years, 5 years, 10 years and 15 years, and marginally outperformed over the 20-year period. This means that it performed strongly between 2000 and 2005 (when it was a lot smaller), but it has found it more difficult over the last decade.
Don’t get me wrong. I am a fan of both Argo and AFI (with their low-cost investment models), but at the right price. The trade is to sell Argo and AFI, and replace with broad based index tracking ETFs, probably VAS or IOZ. When they go back to a discount, you can potentially reverse the trade.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.