- Switzer Report - https://switzerreport.com.au -

LICs are superior investments: Wilson

Posted By Geoff Wilson On In Markets,Other investments,Shares | No Comments

Twenty years ago, I read a research report that showed how Listed Investment Companies (LICs) in America had outperformed mutual funds by over 1.5% each year since the 1940s. It changed my way of thinking and I realised the best way to invest in a portfolio of shares was through an LIC.

Since then, I’ve established a funds management business using the LIC structure to deliver consistent returns to our investors. Recent research from Morgan Stanley Smith Barney reiterates the report I read back in the 1990s. It shows that Australian equity LICs have delivered a 144% higher return than the broad Australian equity market since 1979, as shown in the table below.

LICs vs the ASX

[1]

Source: Morgan Stanley Smith Barney

The LIC structure is a superior investment structure, and can occasionally provide you with the opportunity to buy $1 worth of shares for 80 cents – I didn’t think that it was possible! At times people sell things in the stock market for below what they’re worth; it seems illogical, but it’s true. Some investigation is warranted as to why, but often ‘quality’ companies can be bought at a discount to their value.

What is a LIC?

A LIC is an equity fund: it is a professionally managed share investment portfolio that is listed on a securities exchange like the ASX. Like unit trusts, LICs are pooled funds invested in a diverse range of shares. Unlike unit trusts, LICs are incorporated as quoted companies and instead of buying units in a fund, investors buy shares in a company.

LICs are excellent investment vehicles that can give exposure to a range of different investment opportunities from Australia to China.

They are closed-end funds with a fixed amount of capital. No one can buy shares in an LIC unless someone else is willing to sell. This is the principle difference with exchange-traded funds (ETFs), which are open-ended, meaning new units can be created to fill demand. Therefore the share price of an LIC moves according to the rules of supply and demand rather than as a direct reflection of the movement in its underlying assets. Thus LICs often trade at either a premium or a discount to the value of the assets they own – their Net Tangible Assets (NTA). This can create opportunities for investors.

It is this premium or discount that can make LICs appear complicated. Most investors are familiar with unit trusts, which quote their unit values every day. Investors can buy or sell the units at the stated daily NTA. With LICs, the variance between the value of the LICs assets and its share price can offer a significant opportunity.

Buying opportunities

In Australia, there are 57 LICs listed on the ASX with a value of $16.4 billion. Currently, at least 46 of them are trading below the value of the shares they own, creating a number of great value investing opportunities for the astute investor. In a moment, I’ll explain why there’s good reason to believe that many LIC unit prices may soon trade at a premium.

The first investment trust was launched in the UK in 1868 by Foreign & Colonial. It planned to raise £1 million to invest in government stock of foreign countries and colonial territories aiming “to give the investor of moderate means the same advantages as the large capitalist in diminishing the risk of investing in foreign and colonial government stocks, but spreading the investment over a number of different stocks”.

Some good performers

The Australian LIC sector dates back to the 1920s. The oldest investment company that is still listed is Whitefield Ltd (WHF), which was incorporated in 1923. The largest Australian LIC started life in 1928 as Were’s Investment Trust Ltd. Now called the Australian Foundation Investment Company Ltd (AFI), it has assets of $4.8 billion.

Over the years, LICs have been floated on the ASX. Some have grown and prospered – like Argo (ARG), Milton (MLT), Kerr Nelson’s Platinum Capital (PMC) and our group, WAM Capital Ltd (WAM), WAM Research Ltd (WAX) and WAM Active Ltd (WAA). Others have been taken over or returned their capital to shareholders.

A bright outlook for LICs

The outlook for LICs in Australia is the brightest I have seen in my 32 years working in the securities industry. The sector is currently benefiting from two major structural changes.

The first is the change to the Corporations Act in June 2010, allowing companies to pay dividends as long as they are solvent. This change gives companies greater flexibility with dividend payments.

The second significant structural change is the reform of the financial planning industry. The abolition of trailing commissions will remove a significant impediment for financial planners recommending LICs and other listed investment products (such as ETFs) to their clients. LICs don’t pay trailing commissions and for years financial planners have had a significant financial incentive to recommend managed funds over LICs. Thus, LICs have not fully benefited from the significant growth in the funds management industry that has taken place over the last 20 years (from $157 billion in 1990 to $1,199 billion). The playing field will finally be level and we are already seeing an increased level of interest from financial planners in LICs.

Going up

Since these regulatory changes were first discussed, the discount to NTA of a number of LICs has decreased. I believe this will continue and may well result in a large number of LICs trading at a premium to their asset value.

Advantages of LICs at a glance

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. Anyone should, before acting, consider the appropriateness of the information in regards to their objectives, financial situation and needs and, if necessary, seek professional advice.

Also in the Switzer Super Report