By Hugh MacNally
DOMINIC McCormick’s recent column (Money Management, Dec 11, p15) predicts disappointment for those investing in the raft of new listed investment companies (LICs) coming onto the market. We believe his column vastly underestimates the strengths of these LICs, and the opportunities they offer investors seeking a boutique-style investment approach.
The column included the following observations:
• the plethora of LICs coming to the market is indicative of a bubble;
• they are misunderstood by investors;
• there are advantages to the structure but they are more for traders to take advantage of;
• they may have some tax advantages;
• the management contracts are too long;
• they will likely trade at big discounts to their NTA; and
• they are not researched.
We believe planners, brokers and investors need to consider these points.
What bubble?
Firstly, the LIC market is far from approaching a ‘bubble’ scenario. While there have been a number of recent issues, the volume of funds being raised amounts to $700-800 million and brings the total capitalisation of LICs to approximately $9 billion — compared with the total value of funds managed in Australia of $700 billion (IFSA). Hardly a bubble!
In the US and UK this type of vehicle is far more common, accounting for closer to 10 per cent of the total market, rather than our 1 per cent.
Do investors know what they are buying?
We disagree that LIC investors are confused about what they are buying. The fact is, investors are snapping up LICs because they are not another managed fund. The retail market is showing a clear willingness to give boutique investment teams with good track records a go. If these investors are buying the LICs as a way of accessing a manager’s expertise, long term, then we think that Mr McCormick’s short-term concerns are irrelevant.
A LIC is a listed company and as such is subject to the disciplines of the Australian Stock Exchange listing rules and the requirements of corporate governance.
Investors also seem to be attracted to managers’ refreshing openness, and willingness to communicate what they are doing and why. Generally, there is little in the way of marketing spin.
Tax is important
The ability of an LIC to pass the concessionary tax rate on capital gains tax to their shareholders is a major positive development for these vehicles. Where the LIC intends using these provisions, and not all can, particularly if they are a trader, they include an opinion in their prospectus from a tax specialist. For planners, this represents a significant advantage in ensuring a tax efficient approach for clients.
Costs are lower
Most of the recent LICs have an option attached, which to the purist may seem off key. However it could be argued that this provides a way of lowering the cost of subscribing to the LIC. Generally, the costs of an issue are a little over 2 cents for a $1.00 subscribed, however the full 100 cents of the option exercised goes to the LICs. Thus, if the option is exercised the investor will have contributed $2.00 with costs of approximately 2 cents —effectively a cost of entry of only 1 per cent.
Management contracts
Are the long management contracts a good thing? We believe a key benefit of LICs is the alignment of investor/ manager interest. When investors buy an LIC they are investing because of the underlying manager. The management contract provides protection against the manager being replaced.
Trading at a discount
It is often perceived that LICs trade at a discount to their asset backing for long periods of time. However the facts show differently.Goldman Sachs JB Wererecently created a graph of an index of listed investment companies that shows the discount/premium to NTA in percentage terms over the last 15 years — from immediately after the 1987 crash through the bear and bull markets of the 1990s to date. For most of the time, the index has been between 5 per cent premium and 5 per cent discount to the aggregate NTA with brief periods of more than 10 per cent premium or discount.
Fortunately, there seems to be a number of investors that are waiting around for the opportunity to buy assets at a discount — a very good strategy in our view! As a result, large discounts are only temporary.
Where’s the research?
Research is an important tool for planners and another area we expect will quickly catch up with the traditional managed funds sector. It used to be that few brokers would actively recommend LICs as some believed this tended to tie the client’s money up for long periods of time. However, as one senior broker recently observed (in support of an LIC that his firm was raising funds for), what these vehicles actually did was bring in new money that the client advisers did not otherwise see.
Furthermore, a number of brokers with large private client businesses are starting to research LICs, indicating that the market for LICs will grow in the way the listed property trust market has over the last 15 years.
As a boutique manager about to launch our own listed vehicle, we believe LICs provide a useful and viable investment alternative with cost and tax advantages, as well as greater transparency. Their longer-term nature is clearly more suited to the longer-term horizons of many investors, particularly those with DIY super funds.
Hugh MacNally is a founder and director of Private Portfolio Managers (PPM). PPM is listing its own LIC in early February.
