What is a Listed Investment Company (LIC)?
LICs are listed investment vehicles popular with Australian investors because they are both easy to access and offer investors several advantages over other “investment fund” type products like managed funds and exchange-traded funds. However, investors should ensure they understand the closed-ended structure of LICs before investing.
Read on to learn about Listed Investment Companies (LICs), and the reasons why investors consider LICs as part of their portfolio investment mix.
What is a LIC?
LICs are investment entities incorporated as companies and listed on a stock exchange like the Australian Securities Exchange (ASX). These vehicles then invest in a diversified portfolio of assets, actively managed by professional teams on behalf of investors. However, unlike traditional managed funds, investors can buy and sell LICs in the same way other securities on the ASX are traded. A key feature of a LIC is the closed-ended structure, which means they don’t issue new shares (or cancel existing shares) as investors join or leave. Instead, they issue a fixed number of shares in an initial public offering (IPO) and investors then buy and sell these on the exchange. This ability to raise capital from thousands of investors at a single point in time differentiates the LIC structure from ETFs and unlisted managed funds, where investors may apply and redeem units at any time. As LICs are companies, they may pay franked dividends.
LICs compared to LITs, ETFs
While LICs and Listed Investment Trusts (LITs) are both closed-ended structures, there are some differences between them − particularly from a tax perspective − which are important to understand before investing. ETFs, by comparison, are normally open-ended and new shares are issued every time a buyer makes an investment (and cancelled when the units are sold). This means the value of the shares or units of a LIT or LIC can differ from the ‘true value’ of the underlying assets that it might hold in the portfolio, potentially giving LIC or LIT investors an advantage over ETF investors. Another difference is that while ETFs and LITs are trust structures legally compelled to pay out all income to their beneficiaries every year, LICs can ‘store’ dividend payments to smooth out income payments to its shareholders when markets are weaker. Finally, LICs are only ever actively managed while ETFs are traditionally passive index trackers, despite the strong recent trend towards active ETFs.
LIC costs and buying at the right price
LICs are relatively low-cost investment options and fees are generally below those of comparable managed funds but more than ETFs, although investors in the latter will incur brokerage fees every time they trade an ETF unit. While investors should do their homework before any investment, LICs may require some extra research as they usually trade on the ASX at a price which is different to the net tangible asset (NTA) value of their underlying investments. The NTA is calculated by dividing the value of all the investments and other assets the LIC holds (less any liabilities) by the number of shares on issue. It is therefore possible for the share price of the LIC to trade at a premium or discount to the NTA value. There is no one rule which determines the right price to pay, although investors typically prefer to buy LICs at a discount. Investors typically consider factors such as historical performance, dividend payout, liquidity of underlying assets, portfolio concentration, market value and the prices of similar LICs before committing. They should also be forewarned that they may struggle to find a buyer for a LIC shareholding that consistently underperforms, even if it is trading at a significant discount to its NTA value.
Benefits of LICs
One of the key features of the LIC structure is the ability to pay franked dividends. Because of their corporate structure, a LIC can retain earnings and reinvest them into the portfolio or pay dividends out of profits. This stable stream of franked dividends can be particularly appealing to investors, especially retirees, seeking reliable and tax-effective income in an environment of market volatility and low interest rates. Another potential LIC advantage is the ability to assist investors in diversifying their portfolios across asset classes, sectors and geographies that otherwise could be difficult to access. For example, there are LICs that cover international shares, emerging markets, specific sectors, and corporate bonds. This strategy has the potential to provide the best of both worlds to investors: active management that lifts returns and a consistent income stream that can make a big difference to portfolio returns over a long investment horizon.
Tax advantages/disadvantages of LICs
LICs pay company tax on their income before distributing it to shareholders in the form of a franked dividend. This is generally at the current Australian company tax rate of 30%. If an investor’s marginal tax rate is below the corporate tax rate of 30%, they will generally receive a refund from the Australian Taxation Office for the difference. This is another key differentiator from managed funds as LICs pay tax and pay out higher fully franked dividends to investors. As a result, post-tax comparative returns can understate the returns of LICs versus managed funds. A LIC paying a dividend will advise its shareholders how much of the dividend is attributable to a LIC capital gain. However, LICs tend to have a higher portfolio turnover than index ETFs, which can create an ongoing ‘tax drag’ from realising more capital gains each year. ETFs pass all dividends through to unitholders.
Future trends: LIC or ETF?
LICs and ETFs are both very popular investment choices among retail investors in Australia. They have many similarities but also some important differences investors should be aware of. So, which one is right for your portfolio? Both investment options are assessed relative to each other here.
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