Australian investors are becoming less willing to pour money into costly managed funds when other investments such as listed investment companies (LICs) do the same thing for a fraction of the price. Both LICs and managed funds are share portfolios that are externally managed by a professional fund manager – the difference being that LICs are listed on the sharemarket and managed funds are not.

An LIC can be a handy addition to your portfolio since your chosen LIC can sit alongside your Rio Tinto and Westpac share holdings in the same share trading account. This can make reporting and monitoring your portfolio much simpler than holding a mix of shares and unlisted managed funds, which are purchased as units from a fund manager not as shares from the ASX.

If you think that LICs are simply another new-beaut product to hit the market, think again. The oldest LIC in Australia, Australian Foundation Investment Company (AFIC) is 79 years old. Other older LICs include Choiseul, Milton and Argo Investments.

Since LICs act like ordinary shares, when more investors buy a particular LIC its share price will rise. Likewise, when investors sell out of an LIC its share price will drop. Analysts like to spend time comparing the current share price of an LIC with its underlying value, called its net tangible asset (NTA) backing. LICs can trade at either a discount or premium to their NTA.

Loyal investors in the 79-year old Australian Foundation Investment Company (AFIC) have received a 13.64 per cent return over the past ten years (this includes share price gains plus the reinvestment of dividends). Yearly management fees to 30 June 2007 were 0.13%, comparing favourably to traditional managed funds charging unit holders 2 per cent or higher in fees each year. The company is proud of the fact that it has paid a dividend every year since its inception with the exception of the Depression in 1930.

 

Top Australian Brokers

 

You could probably count the number of managed funds with a comparable track record on one hand. The Perpetual Industrial Share Fund is certainly a fund that springs to mind – netting 13.89 per cent on average over the past 10 years – but consistent long running returns like this aren’t easy to find in the managed fund space.

AFIC’s managing director Ross Barker says it has been a shareholder of Coles Group, the Commonwealth Bank, BHP Billiton and Wesfarmers since each of their respective listings. It’s typical of older LICs to hold large, stable portfolios with little turnover. AFIC, for example, holds 100 stocks and will generally turnover only 10 per cent of its portfolio each year.

Self-funded retirees are attracted to LICs because dividends are always fully franked, rather than partially franked as is common with managed funds. Typical yields are 3 to 4 per cent.

It’s not uncommon, however, for LICs to periodically weather bad press as they fall out of favour with investors and share prices sag. Typical moments of unpopularity are during booming sharemarkets, such as what we’ve experienced over the past four years, when investors ditch LICs for direct shares or more aggressive managed funds. An avalanche of new listings can also push the average share price of LICs lower as the market grapples with the extra supply.

Today there are over 60 LICs trading on the ASX across Australian shares, international shares, private equity and specialist LICs including global mining funds. But according to broker Goldman Sachs JBWere about 80 per cent of Australia’s LICs underperformed the All Ordinaries index in the last three years. But as we touched on earlier, this is fairly standard behaviour in an equity bull run.

“There’s a seriously big explanation, and it’s called the resources boom,” refutes Argo Investments chief executive Rob Patterson. According to Patterson, LICs traditionally go underweight in resource stocks – which have underpinned the current bull run -because they are highly speculative. But resource stocks don’t pay high dividends like the banks.

“Yield is one of the key things that our shareholders want,” retorts Australian Foundation Investment Company Ltd (AFIC) chief executive Ross Barker.

Out of the 16 LICS in the Goldman Sachs survey, just three had portfolios that beat the All Ordinaries Accumulated Index compound annual return in the three years to 31 October of 27 per cent. Contango Microcap was a top performer, generating a return of 38 per cent, including dividends. The two big LICs, Argo and AFIC, weren’t far off the index, with their portfolios returning about 23 per cent and 22 per cent respectively.

The trouble for investors in LICs is that it never seems to be the right time to buy. When LICs lose favour, as has happened over the past three years, everyone is quick to point out lagging performance and sagging popularity. LICs typically trade at a discount to their NTA during these times. However during more bearish market conditions – when LICs spring to life again and share price bounce to a premium to NTA – they can be branded as expensive. So what should you do?

Most analysts tend to look to buy LICs at a decent discount to NTA, or cheaply. So in that sense, less favourable times are probably the best opportunities to hop on board.

To determine whether or not a LIC is trading at a discount or premium to its NTA you can compare its current share price to its pre-tax NTA, announced each month by the company. Simply go to the ASX website and after typing in the company code you can download both its current share price and recent company announcements. It’s also worthwhile perusing the Investment Centre on the ASX website and then clicking on Listed Managed Investments for more education on LICs.