Investors in Australia’s biggest Listed Investment Companies (LICs) have seen their investments crunched on the stock market over the last couple of months. In a relative sense, shares in these companies have materially underperformed. Since the end of February to last Friday, in a period where the S&P ASX 200 accumulation index added 10.28%, Argo (ARG) has fallen by 1.5%, while Australian Foundation (AFI) and Milton Corporation (MLT) have added just 2.8% and 4.6% respectively.
This underperformance is a function of the share price premium evaporating and moving back to par, or in one case, a tiny discount. Potentially caused by investors taking advantage of the huge premium and switching into other investments (such as Geoff Wilson’s new IPO WAM Leaders Limited), it highlights one of the real problems (some say opportunities) with LICs, premiums or discounts.
And it is this discussion of premiums or discounts that leads me to address one of the most frequently asked questions by investors – which is the best-managed investment?
While many investors prefer to construct their own portfolio of direct shares, others see the advantages of using a managed investment – particularly if they don’t have a lot of time to follow the market. Some investors use managers to complement a portfolio of direct shares – while others go the opposite way and run a core portfolio with a manager and then invest in individual shares as the satellite component.
Two of the easiest ways to gain exposure to the market are through broad based LICs or index tracking Exchange Traded Funds (ETFs). Listed and traded on the ASX, both are managed investments. Whether you choose a LIC or an ETF, and in the case of the LIC, which one, I maintain should largely come down to the premium or discount.
Exchange Traded Funds
Most ETFs are designed to track an index. They are on “autopilot” – the manager invests and maintains the investment in accordance with the index. If the index weight for Commonwealth Bank is 9.4%, very close to 9.4% of the ETF will be invested in Commonwealth Bank shares. The Manager doesn’t try to beat the market – all he/she does is to try to reduce the index tracking error.
With their low management fees, they should provide a return that closely matches the return of the index. Nothing more, nothing less.
The major market cap ETFs are set out below. They all track broad based indices, with both IOZ and STW tracking the S&P/ASX 200 (IOZ from 1 December last year), while VAS tracks the broader S&P/ASX 300. Fees are very competitive. Performances to 30 April 2016 (after fees) are shown below, as is the benchmark S&P/ASX 200 accumulation index.
Major Exchange Traded Funds
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Returns to 30/4/2016. Source: Respective Managers
The major advantages of an ETF over a LIC are improved transparency and market pricing. ETFs update their NTA every working day, sometimes intraday (IOZ and VAS), and due to their fungibility and appointment of market makers, you will buy or sell an ETF within 0.10%/0.20% of the NTA of the fund. The premium or discount should always be small. Unlike LICs, they don’t offer share purchase plans.
IOZ pays distributions quarterly, whereas STW and VAS pay half-yearly.
The Major LICs
There are three major broad market LICs – AFIC or Australian Foundation Investment Company, Argo Investments and Milton Corporation.
They are big, professionally managed and very credible investment companies. Milton Corporation, for example, was listed on the ASX in 1958 and has paid a dividend to its shareholders every year since.
LICs are actively managed. That said, these broad market LICs essentially invest in the major blue chip companies, placing considerable emphasis on companies that have reliable earnings, pay fully franked dividends and have an ability to grow these dividends.
An investment précis is set out below.
As the table demonstrates, the funds have, in the main, marginally outperformed the S&P/ASX 200 accumulation index over longer time periods.
While each fund uses a different benchmark, comparison to the same index over identical periods (in this case, the year ending 30 April) makes it easier to make an informed judgement.
They have had mixed performances over shorter periods, with AFIC underperforming and Milton outperforming.
Over 10 years, however, AFIC leads Milton, with Argo in third place.
Major Listed Investment Companies
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Returns to 30/4/2016. Source: Respective Managers
An advantage of LICs compared to ETFs is that they usually offer share purchase plans, which may allow shareholders to subscribe for new shares at a marginal discount to their underlying value or NTA (Net Tangible Asset value).
A major disadvantage is that as close ended funds where new investors become investors by buying shares from other investors on the ASX, the LIC can at times trade at a significant premium or discount to its NTA.
LIC or ETF?
The tables demonstrate that despite their different investment styles, objectives and benchmarks, the broad market LICs can be expected to deliver an index style return plus or minus a fraction, and the ETFs an index return less a fraction. While this is not a “given”, the outcome is not that surprising, given the concentrated nature of the domestic share market and the relatively conservative investment style adopted by the LICs.
So, the answer to the question LIC or ETF? comes down to the premium or discount that the LIC is trading at.
The graph below shows Argo’s share price compared to the underlying NTA. At times, it has traded at a discount of up to 15% (typically in bear markets), and at other times, a premium as high as 17% (typically in bull markets). More recently, this range has narrowed to 10% either way.
Argo’s Share Price to NTA – Relative Premium/Discount
Source: Argo
Over the last 12 months, most of the LICs have been trading at premiums, sometimes over 10%.
However, the premium has been smashed over the last couple of months, and has now closed right in.
Two of the major LICSs closed Friday at a small discount!
Discount/Premium (as at 30 April 2016)
*NTA sourced from Company Reports
Estimated Discount/Premium (as at 13 May 2016)
*NTA estimated by Switzer Super Report, based on reported 30 April NTA adjusted for the movement in the S&P/ASX 200 Accumulation Index
Using an assumption that the LIC will outperform the ETF by around 0.40% pa (or say 2% flat over a 5 year period), then the question can be answered as follows:
If the LIC is trading at a discount or a small premium (say < 2 or 3%), then invest in the LIC%;
otherwise, invest in the ETF.
While there is arguably a little more variability in the return from the LIC than the ETF (because the former is actively managed), the flipside is that its return may indeed be better than 0.40% pa. There is also some manager risk – so you may want to spread any investment across two LICs.
Calculating the premium or discount
LICs are required to publish their NTA each month (ASX announcement, plus on their website), which is generally available by the 5th working day of the following month.
At other times, you can quite accurately estimate the NTAs for the broad market LICs. Take the last published NTA, and adjust it up or down by the percentage movement in the S&P/ASX 200 since the calculation date (i.e. end of month). To calculate the premium or discount, compare the estimated NTA with the current market price on the ASX.
Which one?
My ranking of the ETFs (based on management fees and index tracked) is:
- VAS (Vanguard)
- IOZ (iShares)
- STW (SPDR))
There is very little in this assessment – any of these ETFs could be selected. It is heavily influenced by fee, and a longer-term view that smaller companies will, in time, do better and hence a preference to opt for a broader index (the S&P/ASX 300 rather than the S&P/ASX 200). IOZ, with its quarterly distribution, may suit some investors.
With the LICs, Milton Corporation has the best short-term performance, and is first in the five year and second in the 10-year measures. While it is a fraction more expensive in the premium/discount stakes, the differences are pretty small. Argo marginally gets the nod over AFIC for second spot. Again, in a very tight race, my ranking for the LICs is:
- MLT (Milton Corporation)
- ARG (Argo)
- AFI (Australian Foundation Investments)
Buy LICs
Overall? The broad based LICs are now attractively priced. With almost no premium, long-term investors looking for broad-based exposure should consider LICs in preference to index based ETFs.
Important: 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. Consider the appropriateness of the information in regards to your circumstances.
