Should I Buy a Listed Investment Company on the ASX?
There are many ways to buy stocks in the exchange. Aside from acquiring shares of individual companies and investing in exchange-traded funds (ETFs), you can opt to buy shares of listed investment companies or LICs.
What is an LIC?
An LIC is an investment vehicle that provides access to a diversified portfolio similar to what an ETF does. They are listed in the ASX and can be traded like any other stock in the market.
LICs, together with Listed Investment Trusts (LITs), compose most of the managed funds listed in the ASX. These types of managed funds give investors instant portfolio diversity handled by a professional fund manager.
ETFs are categorized under trust funds, while LICs are listed as companies. This creates a huge difference on how money is handled by these investment options.
Just like any other listed company, an LIC raises capital by performing an IPO. Interested investors can then buy the shares of the company and trade it in the market.
LICs are managed with close-ended funds. This means they can’t add more shares without going through the capital raising process first. LICs benefit from this structure since the fund itself doesn’t get affected by the money that revolves when investors buy or sell LIC shares.
LICs differ from the type of assets they hold. There are special funds that target a specific asset class like mining, small caps, and international shares.
Here are the 4 investment categories LICs usually belong to:
- Australian shares – this type of LIC is heavily invested in listed stocks in the ASX.
- International shares – this one focuses more on shares listed on international stock exchanges.
- Private equity – LICs invested in unlisted companies, whether local or abroad, fall under this category.
- Specialists – LICs that invest in specific assets or sectors in the ASX like property, technology, industrial, and the likes, are categorized under here.
The investment style for each of these categories depends on the fund manager. Aggressive ones can give higher rewards but the associated risks are much higher compared to a conservative approach.
How do LICs work?
The underlying investments forming the portfolio are used for computing the net tangible assets (NTA) of an LIC. This determines whether an LIC is currently trading at a discount or at a premium compared to its NTA.
When the price of a certain stock (one that’s also included in the LIC portfolio) falls below the NTA, it can be a signal to get into an LIC. This is because you’ll be buying at a discount to get a basket of different stocks compared to acquiring them separately on the exchange.
However, buying at an NTA discount doesn’t guarantee higher returns. Liquidity can become an issue for LICs. The discounted prices can remain at that level while individual stocks included in the fund soar to new highs, further widening the gap between the NTA and the actual share price.
Difference from ETFs
In other managed funds like ETFs, when an investor sells theirportion of the fund, the manager is forced to sell shares at lower prices. The incurred loss may affect the overall performance of the portfolio.
Many fund managers see buying opportunities when the market is on a selldown. However, since their clients are withdrawing because of panic, the available funds get reduced, decreasing the buying power of the portfolio.
On the contrary, investors are enthusiastic to buy when prices are soaring. Fund managers are then forced to buy shares at bloated prices, making it harder for them to maximize profits. When the bull run ends, the fund may experience devastating losses.
LICs, since they’re close-ended, don’t experience these issues. Money doesn’t enter or leave the fund similar to how transactions go in ETFs. In every transaction, only the investors change.
LIC managers don’t have to sell a strong stock in order to compensate the money withdrawn by leaving investors. This gives managers focus on growing the portfolio instead of maintaining the fund’s cash flow.
Most ETFs track index stocks, which means they’re more stable and less susceptible to sudden price fluctuations. However, they’re also more conservative in terms of profit.
LICs, on the other hand, have goals of outperforming the index. This means higher returns in exchange for higher risks.
ETFs are more balanced and diversified. It can contain any number of stocks – from 10 to 100 – depending on the investment approach. LICs, tend to be more focused to maximize potential gains from specific asset classes.
Capital gains are distributed to ETF shareholders. LICs, on the contrary, distribute fully franked dividends where the company tax of 30% has already been paid.
Pros and Cons
Here are some pros and cons of investing in an LIC.
- LICs can be easily traded like ETFs but they’re not as liquid as your typical corporate stocks.
- LICs are much more transparent in disclosing their NTA values compared to other managed funds.
- You become eligible to receive franked dividends from the profits of the LIC.
- Many LICs expose investors to a broad range of assets available locally and abroad. This gives investors more options to choose from, depending on their risk appetite and reward expectations.
- Since LICs are exposed to a variety of assets, they’re more susceptible to market volatility. Unlike ETFs that follow the index stocks, LICs can be invested in stocks with low market capitalization which is riskier.
- Fees are often higher on LICs compared to ETFs.
- LICs usually have an annual management fee ranging between .13 to 2.33% of the net value of your assets. Some LICs also apply a performance fee ranging from 15 to 20%, depending on how well the fund does.
- There will be times when the NTA and actual market price of a stock diverge.
There are over a hundred LICs included in the ASX. Established LICs usually trade at a premium due to their history of producing good returns. On the other hand, newer LICs typically trade at a discount because they have yet to prove their company’s value.
Here’s a list of the best picks based on market capitalization:
- Australian Foundation Investment Co.Ltd. (AFI)
- Argo Investments Limited (ARG)
- Djerriwarrh Investments Limited (DJW)
- WAM Capital Limited (WAM)
- Carlton Investments Limited (CIN)
- Platinum Capital Limited (PMC)
- Whitefield Limited (WHF)
- Mirrabooka Investments (MIR)
- Templeton Global Growth Fund Ltd (TGG)
- PM Capital Global Opportunities Fund Ltd (PGF)
- WAM Research Limited (WAX)
- Contango Microcap Ltd (CTN)
- Westoz Investment Company Limited (WIC)
- Aberdeen Leaders Limited (ALR)
- Ozgrowth Limited (OZG)
- Katana Capital Limited (KAT)
- Acorn Capital Investment Fund Ltd (ACQ)
- WAM Active Limited (WAA)
LICs also have fund managers responsible for picking stocks to include in the portfolio. Do your due diligence in knowing the experience and expertise of these fund managers. This will boost your confidence in deciding which one of them will handle your money.
Just like ETFs and individual stock shares, there are advantages and disadvantages in investing in an LIC. Perhaps the largest benefit of getting an LIC is the part where you get fully franked dividends. This means, though, that you have to acquire and hold a considerable amount of shares to fully enjoy the rewards.
If you want higher returns and you’re ready to take higher risks, you should give LICs a try. But if you’re conservative and you want to play on the safer side of the jungle, ETFs are more suitable for you.