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Should you buy Cadence Capital and other LICs?
A reader question concerning Cadence Capital, a small listed investment company (ASX:CDM) has triggered my interest in this sector. The reader asked, “What is a listed investment company and why is Cadence doing so well – am I missing something?”
What’s an LIC?
In concept, a listed investment company (LIC) is very similar to a managed fund, although with a few key differences. Firstly, they are closed-end funds – that is, the investment pool is finite and can only be increased by the company issuing new shares. Unlike a managed fund where new units are created each time an investor makes a contribution, or units are cancelled each time an investor redeems (withdraws) funds, investors can only invest by buying shares from another shareholder. This is done on the ASX and although the shares have a ‘theoretical’ net tangible asset value (NTA), the market ultimately determines the value of the shares.
The other difference is that sometimes the funds are internally managed, meaning that the investment managers are effectively the ’employees’ of the shareholders. In the bigger LICs, this results in low indirect investment costs (effectively the same as the ‘management expense ratio’ or MER of a managed fund), as the only costs are employee remuneration and transaction expenses. Smaller LICs will often contract the investment management to a third party company, which may be related to the directors.
LICs are not new – they have been around for several decades. There are more than 60 LICs traded on the ASX, dominated by the two ‘gorillas’ Australian Foundation Investment Company Ltd (AFIC) and Argo, and supplemented by a number of niche high alpha-type funds.
Let’s start with the gorillas. AFIC (ASX:AFI) is the largest. An offshoot of the old ‘House of JB Were’, it boasts a pretty credible long-term investment performance focusing on companies with strong businesses, prudent gearing and cash flows able to support growing dividends. Its investment portfolio looks a bit like the ASX 20 Leaders, with some changes in weighting around the edges. Post GFC, its secondary market price (like all LICs) has been trading at a discount to its NTA, so it has started to gear, raising $220 million through an issue of unsecured convertible notes.