Our General Manager of Business Development and Investor Relations, Geoff Driver, recently joined Owen Rask on The Australian Investors Podcast. Alongside Dan McCleery from Acorn Investment Company and Amanda Lambert from Qualitas Real Estate Income Trust, Geoff discussed the relevance of Listed Investment Companies (LICs) in the modern market, how understanding and acceptance of LICs has grown, how they compare to Exchange-Traded Funds (ETFs), the importance of strong management, and key considerations for investors when considering different investment vehicles. Below is a summary of the conversation.
The evolving landscape of LICs vs ETFs
Listed Investment Companies (LICs) like AFIC have been around for 100 years. With the number of LICs increasing over the past 20 years, they have carved out a position within investment markets, appealing to investors seeking potential outperformance and long-term returns, especially during periods of market volatility. More recently we have seen Exchange-Traded Funds surge in popularity driven by investors seeking lower-cost alternatives to unlisted managed funds, strong marketing, and their large-scale operations. Both investment vehicles provide investors with access to a diversified portfolio of companies, however, there are important differences.
A key difference between an LIC and an ETF is their structure. LICs are closed-end investment funds that issue a fixed number of shares. Under this structure, the LIC determines when to raise more capital.ETFs are open-ended funds that issue and redeem shares based on demand at the time.
The closed-end structure of AFIC’s LIC allows us to focus on quality companies, capitalise on compounding returns, and recognise opportunities in the market to buy undervalued, quality companies or sell holdings when we believe they’re over-valued. Unlike open-ended funds, we’re not forced to buy or sell assets based on short-term market fluctuations. This approach provides opportunities, especially during market downturns, as we can acquire undervalued companies at attractive prices.
However, being a closed-end fund LICs can at times trade at a premium or discount to their underlying assets, which is different from ETFs tend to generally track the value of the portfolio, and it’s important that investors understand why this can happen and not to buy at large share price premiums.
The LIC market has seen a significant influx of new offerings in the last 20 years, and unfortunately, it has left some investors with both good and bad experiences. This underscores the importance of investors doing their due diligence when evaluating LICs, and for managers such as AFIC to continue to educate investors about the characteristics and benefits of LICs. We believe, like any industry, the significant expansion in the number of LICs in the market will eventually contract and/or consolidate as many of these funds revert to an open-ended structure or cease to operate.
Dividend income
There is no guarantee of dividends in either a LIC or ETF, however, the core difference is that a LIC, particularly one with some scale, can build up profit reserves over time to be able to continue paying dividends during times of market volatility. For example, over the COVID-19 period, the market cut dividends by 25% generally, but AFIC maintained paying dividends to shareholders because it had profit reserves and a store of franking credits.
ETFs as trust structures have to pay out all their profits and realised capital gains in the form of distributions to their shareholders every year. This means they cannot build reserves and therefore may have fluctuations in dividends through more turbulent economic times as companies reduce dividends.
Transparency and Fees: Know what you’re comparing
LICs have faced some criticism around a lack of transparency regarding fees. We would argue there is transparency, but unfortunately, there is no standardised approach across all LICs so it is difficult to compare apples with apples. However, LICs are generally required to report their NTA monthly and financial statements every six months and should report performance net of performance fees.
Meanwhile, ETFs vary in terms of index tracking or active management, impacting their cost structures. They may also have more complex tax outcomes depending on portfolio activity for the year. Investors should carefully consider these differences when comparing funds.
All our LIC’s are ASX-listed, which means we report on our full and half-year results and produce monthly NTA updates which includes our top 20-25 investments. We also report performance after fees and taxes as it provides the most accurate representation of shareholder returns. Our dividends are fully franked, reducing the tax complexities for shareholders.
Why portfolio managers are critical
At the core of any good investment option is an outstanding management team. This applies equally to investment vehicles like LICs and their portfolio managers and to the companies our portfolio managers invest in.
Investors should consider the portfolio manager's performance history, ensuring it aligns with their stated investment style. A long-proven track record of delivering results over extended periods is essential, and experience navigating various economic cycles and market conditions is desirable. Evaluate their investment process, including adherence to their stated objectives and value proposition.
ETFs are generally passively managed and react to daily market movements, whereas LICs are actively managed. Our funds are internally managed and are relatively low cost. Our team of 12 investment professionals serve four listed investment companies, eliminating external management fees and delivering cost efficiencies to our shareholders.
Our team of portfolio managers also allows us to directly engage with our shareholders and the companies we invest in, a benefit not commonly available with ETFs. We’re committed to engaging directly with our shareholders. Still, we also believe we have a responsibility to consistently raise awareness and understanding of LICs and our funds to the investment community to influence visibility and accessibility.
The future of LICs
As the LIC market evolves, we remain optimistic about its future. The closed-end structure offers a long-term investment perspective, allowing us to focus on quality companies and capitalise on compounding returns to deliver attractive long-term returns to shareholders.