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.
The gorillas
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.
Argo has a similar investment philosophy to AFIC, however doesn’t have any debt. As the table above shows, on all performance measures it hasn’t done as well. That said, a return of 6.6% per annum over 10 years to 31 December, compared with the S&P/ASX200 Accumulation Index of 6.2%, isn’t too bad! These returns are based on dividends paid and movements in the company’s NTA. However, this isn’t necessarily the return that every shareholder received.
The returns
Your return as a shareholder will depend on what you pay for the shares, and the relative premium or discount to the NTA. Over the cycle, LICs tend to trade at a discount in bear markets, and a premium in bull markets. At the moment, most LICs are trading at a discount, with the weighted average across all LICS at 7.5%. Although the discount has been wider, it could be argued that LICs such as AFIC or Argo represent reasonable value.
Cadence Capital
At the other end of the LIC spectrum is Cadence Capital (ASX:CDM). Tiny at around $37 million, this LIC has been going for six years and boasts very impressive performance: gains of 40.8% over the 12 months to December (dividends plus share price movement), and approximately 30% per annum over the last three years! It’s a ‘high alpha’ fund, generating returns from both long and short positions. About 26% of its assets are invested in RHG Ltd, the old Rams Home Loan Group. Negligible liquidity if you want to get out, however, on paper a stellar performance – one for the punters!
ETFs
With the advent of major index ETFs, such as SPDR or iShares (click here [1] for more on ETFs), LICs have lost some gloss. ETFs offer such an improvement in liquidity, negligible discounts/premiums to NTA, and effectively, near guaranteed index performance. If the gorillas such as AFIC can continue to outperform, they have a future. At the other end of the market, there is always going to be room for high alpha-type funds.
The strategy
For an SMSF looking to invest in a balanced portfolio of shares for the long term, AFIC looks like good value. Buy AFIC.
For some alpha, as a satellite investment, get some manager diversification and look for two or three LICs. Study their regular monthly investment updates which disclose their holdings, portfolio changes and NTA – and make sure you are in sync with their thinking about material individual positions.
Important information: 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. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.
Also in the Switzer Super Report
- Peter Switzer: The trend is our friend [2]
- George Boubouras: Dividend stocks: a typical income portfolio [3]
- Rudi filapek-Vandyck: The broker wrap: five stocks to buy and nine to sell [4]
- Tony Negline: Can I get paid for running my DIY super fund? [5]