Originally published by Cuffelinks
Driven by a range of factors, including strong investor demand for fully franked dividends and the introduction of the Future of Financial Advice (FOFA) reforms, the popularity of listed investment companies (LICs) has surged in recent years. Currently, there are almost 100 LICs, up 83% since 2012, offering investors exposure to a range of asset classes, investment styles and markets.
As LIC managers, we believe LICs are a superior investment structure for a range of reasons, as described below. To access these benefits, we invest in other LICs through the LICs we manage. When assessing a LIC as an investment proposition, we consider the following key factors:
1. Quality and integrity of management
Fundamentally, funds management is a people business. It is essential to have confidence in the integrity and ability of the investment manager. An assessment of LIC investment managers should give consideration to the ‘bench strength’ of the entire investment team, not only the high-profile personnel.
Investors should also consider the investment manager’s expertise in managing funds using the LIC structure. We favour specialist LIC managers, as opposed to those who manage money through a number of different types of investment structures.
2. Track record of performance
The performance of a LIC’s investment portfolio reflects the quality of the investment manager and its investment strategy. A proven investment approach will deliver consistent performance in both up and down markets, and the track record must be judged in variable market conditions.
In our view, a truly active investment approach which gives the manager maximum flexibility, including the ability to hold cash, increases the opportunity to outperform the market.
3. Ability to pay fully franked dividends
For many investors, the principal benefit of LICs is their ability to pay a consistent and growing stream of fully franked dividends. In addition to receiving franking credits from underlying investee company dividends, LICs also derive imputation credits from tax paid on realised company profits, unlike managed trusts, LICs retain these franking credits and capital profits in a profit reserve.
Therefore, it is critical to consider a LIC’s ability to pay franked dividends over time. While listed companies are not permitted to disclose future dividend payments prior to board approval, a LIC’s capacity to pay dividends can be determined by referring to its franking account balance and profit reserve in its annual report. For example, a LIC with a franking balance of 50 cents per share, has the ability to pay out a fully franked dividend of $1.17 per share, subject to its profit reserve.
4. Discount or premium to NTA
Distinct from unlisted managed funds, a LIC’s shares can trade at a premium or a discount to its underlying assets, referred to as net tangible assets (NTA). If the per share NTA is more than the share price, the LIC is trading at a discount to its NTA. This can present an investment opportunity as it allows an investor to buy a portfolio of shares for less than their current market value. It can also represent a buying opportunity for investors given the potential for its shares to trade at or above its NTA. If a LIC is trading at a discount, prospective investors should evaluate the likelihood that the LIC will trade closer to or at its NTA by assessing the factors outlined in this article.
5. Marketing and communications
Effective marketing and communications initiatives, such as presentations and regular market updates, are important for building a LIC’s reputation. They raise its profile among investors and the broader investment community, such as financial planners, advisers and research houses. This can increase demand for the LIC’s shares and assist in narrowing or eradicating a discount to NTA.
6. Shareholder engagement
Pro-active, consistent and responsive shareholder engagement demonstrates an investment manager’s respect for their shareholders, without whom they would be redundant. A regular programme of initiatives to engage and communicate with shareholders may include presentations and email updates about the portfolio and market conditions. Effective shareholder engagement can also assist in reducing a discount to NTA.
7. Liquidity and structure
Liquidity is important, particularly when investing large amounts of capital. As a LIC grows through capital management initiatives, such as dividend reinvestment plans, option issues and capital raisings, its on-market liquidity can expected to increase.
The LIC structure also provides an inherent advantage for investment managers. Unlike a managed fund using a trust structure, a LIC provides a stable and closed-end pool of capital, ensuring the manager is not forced to sell investments to fund redemptions (often at the bottom of the market) or buy investments due to inflows (often at the top of the market).
8. Variety of investment exposures
Taking into account their own investment objectives and strategy, investors should consider the investment exposure a LIC provides. LICs offer a diverse range of investments, including different sized companies, asset classes, industries, investment styles and geographic regions. More recently, two philanthropic LICs, Future Generation Investment Company Ltd (AX:FGX) and Future Generation Global Investment Company Ltd (AX:FGG), offer access to a group of fund managers, while also supporting Australian charities.
With minimal investment and for the cost of brokerage, investors can utilise LICs to create a diverse investment portfolio, or compliment directly held investments.
Gathering insights
There are a range of sources to consider when researching and assessing LICs. LIC investor websites, shareholder presentations, reports by independent research houses, media (such as Cuffelinks) and the ASX website all provide useful information to understand and evaluate Australian LICs.