Hi all, I'm interested in people's thoughts on this investment option. I'm not sure how relevant it will be to non-Australians though.
I've got a mixed portfolio of shares, REITs, exchange traded funds and listed investment companies. The more I look into them, the more merits I see to the LICs over ETFs, and I wanted to see what other people think? For disclosure purposes, I own forms of both, VAS, VEU, VTS and IVV for ETF's, and AFI, ARG, BKI, CIN and MLT in the LIC court. I guess I'm having a bet each way.
First up, my understanding is that a listed investment company is a company that invests in shares and securities. If you own a share in the LIC, you own an interest in its underlying assets. They are closed end funds - so if you want to redeem your investment, you sell your share on the market, at the price determined by the market. This may diverge above or below the value of the underlying assets. Not all that different from a managed fund or ETF yet.
LICs have been around the Australian market for a long time - indeed, many of the larger ones seem to date from the 1920's - 1940's. i.e. have survived depressions, world wars and everything in between!
From what I can gather, there are some pros and cons:
- Management expense. The management expense seems to vary between very low (0.1%) for the larger, internally managed companies, up to several percent for the externally managed ones. That gives a similar fee base to the Australian listed ETFs, 0.15-0.3% for domestic shares, and 0.07%+ for the US / international ones. For investing in Australian equities, a slight win to the lower cost LICs.
- Closed end vs open ended. The LICs are closed end funds, while the ETFs are open ended. This means that there is the potential for more turnover in the underlying portfolio (and capital gains) in the ETF. Its also this feature that allows arbitrage of ETFs to keep their price close to the underlying value. Win for the LIC for lower turnover of assets, win for the ETF for keeping prices closer to net asset value.
- discount/premium to asset value. This is where is gets really interesting. ETFs tend to trade close to their net asset value. Where as LICs can deviate (substantially) from their NAV. The ASX publishes a list of these discounts every month - see
http://www.asx.com.au/products/market-update-managed-funds.htm. Some of these discounts are pretty significant - for example, Carlton Investments is currently trading for $17.10, where as its NTA is $22.05. From what I can gather, that means that you are effectively collecting dividends on an extra 29% of your investment! A win to the LIC if its trading at a discount, a win to the ETF if trading at a premium.
- Distribution of income. I think ETFs need to distribute all income to unit holders. Where as I think that LICs have the option to decide their payout ratio. Most of the larger ones seem to have payout ratios between 70% and 100%. I guess the payout / retention advantage depends on if you need the cash flow, if your tax rate is higher than the internal tax rate of the LIC, and if you price in a discount for the risk of the LIC not paying out when you need it? However, the dividend histories of the larger ETFs seems to be pretty progressive - have a look at the dividend history for the likes of AFI, ARG, MLT or CIN.
So, on paper, it would seem that a LIC at a discount to its NAV seems like a bargain, and a clear winner over ETFs. However, given that markets are "supposed" to be efficient, why does such a large disparity exist?
Any thoughts from the other members out there? I think I'm going to keep spreading my eggs between these two baskets, but with a bias towards LICs for new purchases.
What am I missing? Usually if something looks to good to be true it is?