Why everyone wants a LIC
You may think investing and saving money is all about numbers but often it's about fashion. The fashion of investing goes in cycles just like clothes.
Sunday, March 21st 2004, 9:34PM
Once these funds finish their beauty parade and get off the catwalk and into the streets they will join other listed investment companies on the stock exchange including GPG, Hellaby Holdings and Infratil.
What is a listed investment company and why is an outfit like Fisher Funds Management involved in this area?
First up it's useful to note that LICs have been around for decades and are nothing new. There are more than 100 listed on the Australian Stock Exchange and many of the United Kingdom based LICs are dual listed on the NZX and widely used by investors. (In the past they have been dubbed the best-kept investment secret in New Zealand). Right now listed investment companies are the in-thing.
Listed investment companies are quite simply another form of managed fund where people pool their money together and get the expertise of professional money managers.
However there are a few differences in the characteristics of the vehicles. These differences revolve around the structure of the funds, their fees, how they are bought and sold, and how the price is set.
The main structural difference between LICs and managed funds is that the former are closed ended while the latter are open-ended. What that means is when a company raises a sum of money from you and me there is a set amount which doesn't change. It's the pool of money the manager gets to play with and its size will be determined by their investment success less fees.
With an open ended fund - such as a unit trust - the manager has to look after the number of units on issue; redeeming them from people who want out and issuing new ones to investors coming in. Also managers are always trying to grow the size of their funds so the managers have more to play with (and their fee income will grow).
Fisher Funds chief executive Carmel Fisher says this is one of the great beauties of the LIC - as a manager she doesn't have to do anything about looking after the units on issue.
"It’s nirvana for a fund manager to have a closed ended vehicle," she says as money can be raised and invested over the long term without the issues such as providing liquidity to redeem units. This is especially useful when investing in smaller and illiquid companies."
"We can truly act like long term investors," she says.
From this angle LICs are far more efficient to run and give the manager some certainty.
The other major difference, and the area where there is some contention about LICs, is that the market sets the price.
With a managed fund the price is set each day based on the valuation of the underlying investments in the fund. The price which is calculated and published is what everyone in the fund would get if it was closed that day and the assets sold at the prevailing market price.
With a listed investment company the price is set by that hard to catch character Mr Market.
Mr Market establishes his price on sentiment as well as asset value. This price can be either a premium to net asset backing, on par or even a discount.
If you buy into the fund at a premium you are paying more than the value of the assets of the fund on that day, while a discount looks like a good deal - you get assets at below their market price.
The thing which puts many people off LICs is that they often trade at a discount. While it seems like good value buying assets at below market price, it's only a good deal if the discount narrows and moves into a premium situation.
However the logic and reasoning behind discounts and premiums is hard to understand. For instance UK listed investment companies have generally been trading at a discount for years and these discounts had widened - not narrowed until recent times.
In Australia the market price has historically varied significantly from 20% discounts to premiums of more than 30% at any time.
Currently many of the new LICs are actually trading at a premium, even though they are new and, as Fisher points out, nothing but cashboxes as they haven't invested all their money.
Others like Kerr Nielson's Platinum fund has been trading at massive premiums (around 40%) for a number of years. This raises an interesting conundrum as Platinum runs two versions of the fund one listed and one unlisted. People in the former can sell their holding at a huge premium and then buy the same assets in the unlisted fund at par.
From an investor's viewpoint the pricing issue of discounts and premiums is best summed up as one of the risks they face when they consider these types of investments over a managed fund.
Another important difference between LICs and managed funds is that the companies generally - but not always - have an independent board which contracts management. With a managed fund unitholders have very little influence on who actually manages a fund.
With a listed investment company it is a decision made by the independent board and there are shareholder meetings.
Fisher says in the Kingfish structure, which is similar to Infratil, the board can sack the manager for reasons such as poor performance. And it does happen. There have been examples, like the New Zealand Investment Trust, where changes have been made to who is involved in looking after the money.
Likewise listed investment companies have opportunities to use "financial engineering" tools to improve their returns. The two main tools on their workbench are the use of debt and the ability to buy back their own shares.
It is not unusual for a LIC to acquire its own shares when the board considers that the price does not reflect the underlying value.
Also having some leverage in the fund to take advantages of rising markets is a tool which has been widely used, especially by the United Kingdom-based vehicles.
Supporters of listed investment companies also like to point out that they are cheaper than managed funds and there is greater transparency in the way they operate, especially since they come under stock exchange rules. Adding to this attraction is that many of these listed vehicles also have performance based fees - something which is not widely used in the managed fund area these days.
In fact, one of the reasons underpinning the growth of the listed investment company sector in Australia is that people who use managed funds have been disappointed with performance over the past three years and feel the funds are too expensive. They perceive that the listed sector is a better option.
Fisher's explanation of why the Kingfish fund is being spawned gives a good idea of where LICs fit into the market.
She says there are a bunch of investors who would like to get access to things like Fisher Funds Management's investment skills and style, however they would never go near a managed fund because they don't like the structure - for whatever reason. However because a LIC is a share which is traded on the exchange, and its fees are generally lower then it becomes an alternative which they are comfortable wearing.
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