Lesson type: Understanding investment philosophy
Demystifying listed investment companies
Listed investment companies (LICs) now represent about $40 billion of money on the ASX, and they're becoming an increasingly popular alternative to managed funds - but what are they?
Put simply, a LIC is a company that invests in a basket of shares - like a managed fund - except that you invest in it like any other share. So, rather than buying "units" in a "trust," you're trading shares in the LIC as if it were a Commonwealth Bank, BHP or Wesfarmers.
Like one of those companies, a LIC has a corporate structure with a board of directors. Shareholders can interact with management (and each other) at annual general meetings and can sell down their exposure to the LIC by trading on the so-called "secondary market" - other people, basically.
While LICs have experienced a boom over the past few years - there were 181 listed on the ASX as at April 30, up from 157 the year before - they actually have a long track record in Australian investing. The first was launched in 1928 under the name Were's Investment Trust before changing its name to the Australian Foundation Investment Company in 1938.
It wasn't until 2010, though, that laws were changed so that LICs could pay dividends to their investors as long as they were solvent, significantly driving up their attractiveness. You can now buy shares in LICs that invest in Australian equities, global equities, long-short (hedge fund-like) strategies and many other options.
What's the appeal?
Other than the dividend payments mentioned above, LICs have a few key advantages: first, they're "closed-ended," meaning the only way to invest is by buying shares from someone else. That means that unlike with a managed fund, LICs don't have to sell their underlying investments to pay out an investor looking to exit.
Secondly - although this is not always the case - LICs tend to have a particular approach to active management such that investments are generally held onto for long periods, reducing transaction costs. On top of this, unlike a lot of managed funds, LICs aren't required to be fully-invested, meaning if the market bottoms out the LIC can hold a significant amount of cash, preserving value for investors.
Finally, they have to adhere to the same corporate governance rules as any other company on the ASX, meaning they're generally quite transparent and easy-to-understand.
The key concern for LIC investors is whether the company is trading at a premium or discount to net tangible assets (NTA). Let me explain: the NTA is the net value of the underlying investments held in a LIC. So, for example, if a LIC held 10 stocks each worth $10, the NTA would be $100 minus any liabilities.
However, because LICs are traded on a per-share basis, and because the price of any listed company can go up and down based on investor demand (or lack thereof), the stock price of a LIC may be higher or lower than your proportional share of the NTA. This is different to managed funds, which provide the value of units as per the NTA on a daily basis.
In an ideal world, the share price of a LIC would always closely reflect the underlying value of investments, minus management fees. But if a significant amount of shareholders want to sell – as happened during the GFC – the value of your shares could be significantly lower than the NTA.
Whether or not you think a LIC investment is right for you, it’s important to consider these factors as they pertain to your wider investment strategy – and, ideally, consult your financial adviser.
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