Taking Stock 14 March 2024
Fraser Hunter writes:
LISTED Investment Companies (LICs) have been a key tool in New Zealand share portfolios for decades. The premise was attractive: rather than owning a share in a single company, by using an LIC an investor could access a diversified portfolio of assets across a market or strategy, managed by a team of professional fund managers.
The concept was even more attractive for fund managers, who raised capital via an initial public offering and were able to invest and grow these funds for the long term without the worry of client withdrawals. Investors would instead trade amongst each other on the market rather than redeem assets within the fund.
Like a lot of industries, the investment landscape has evolved speedily, with technology, changing preferences and regulation resulting in a new wave of investment options and legacy products and regulators struggling to keep up.
The exponential growth of Exchange Traded Funds (ETFs) has disrupted the traditional fund management industry. One significant trend is the increasing popularity of ETFs, which are known for their low costs and passive investment strategy. This trend has created challenges for LICs, resulting in heightened competition and the need to adjust to evolving market dynamics.
As investor preferences shift towards lower-cost, more transparent investment options, LICs have come under increasing scrutiny and pressure, with many investors perceiving LICs as an outdated, expensive option. This perception has been fuelled by persistent discounts to underlying asset values at which many LICs trade, eating into investor returns.
Offshore, shareholder activism has become more prevalent, with investors voting to shut down funds where they believe discounts may not be recovered, forcing managers to justify their value proposition in a highly competitive market.
Despite these challenges, LICs continue to hold appeal for certain investor segments, particularly those seeking active management and potential alpha (benchmark outperformance) generation. However, to remain relevant, LICs must adapt to the changing investment landscape, embracing greater transparency, cost-efficiency, and responsiveness to shareholder demands.
_ _ _ _ _ _ _ _ _ _ _ _LISTED Investment Companies have a rich history in New Zealand and Australia, as well as the UK. In Australia, LICs such as AFI date back to the 1920s and have been listed on the ASX since the 1970s.
The number of LICs has grown rapidly over the past decade, from 40 to 100 by 2021, driven by investor demand for listed investment vehicles, the popularity of Self-Managed Superannuation Funds (SMSFs), and the desire for predictable tax-efficient income.
In New Zealand, the Listed Investment Company options are scarce, with the main options being the Fisher Funds products, Kingfish, Barramundi and Marlin, offering managed exposure to NZ Shares, Australian Shares and International Shares.
Outside of the Fishers products, the remaining NZX listed LICs are predominantly UK investment trusts, City of London, Templeton Emerging Markets, Henderson Far East, F&C Investment Trust, The Bankers Investment Trust, along with Australia’s AFI.
While the NZX has often expressed a desire to attract LICs to the local market, this has never really taken off. Part of this could be due to relatively high regulatory and listing requirements for our market and not enough demand to attract large fund managers. Local investors already have the option of investing in LICs via the ASX or via investment platforms, as well as alternatives such as ETFs and unlisted managed funds.
Smartshares ETFs have been the NZX’s primary driver of listed fund growth in recent years. Initially, I believed that the Quay Street Funds, acquired from Craigs Investment Partners, might eventually be listed on the Exchange. However, there has been no indication of this happening.
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INVESTORS entering the market have no shortage of options, the key ones being concentrated or diversified, direct or indirect, active vs passive.
Inexperienced or more modest portfolio holders have been encouraged to grow investments under a fund structure, benefiting from collective size to get access to scale, expertise or market access that may otherwise be too hard or expensive for them to get individually.
Low-cost direct share platforms offer access to global shares, though this doesn’t always result in great outcomes for retail investors. Sharesies’ Kiwisaver product for example, has guardrails to essentially protect investors from themselves, capping individual positions at 5% and requiring at least half the funds to be invested with an approved base fund.
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LISTED Investment Companies and Exchange-Traded Funds cater to diverse investor needs, with LICs offering active management and potential tax advantages, while ETFs provide diversification and lower fees.
Despite the rising popularity of ETFs, LICs remain relevant for investors seeking experienced management and regular dividends. The unique characteristics of LICs, such as their active management approach and potential tax benefits like imputation credits, attract investors looking for opportunities beyond passive index tracking offered by ETFs. Additionally, LICs often provide access to skilled fund managers who aim to outperform benchmarks, appealing to investors seeking higher returns through active investment strategies.
Investing in LICs can present opportunities as well as challenges, particularly concerning discounts to Net Tangible Assets (NTA). Discounts occur when an LIC's market price falls below the value of its underlying assets, reflecting concerns about the manager's performance or portfolio quality.
Understanding these discounts is crucial for investors aiming to capitalise on undervalued LICs. Factors like management quality, investment prospects, and the discount/premium to NTA play a significant role in evaluating LIC investment opportunities.
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ACROSS the LIC sector, different types of LICs may be impacted by the discount to NAV (Net Asset Value) issue to varying degrees. For instance, as we’ve seen recently, funds holding illiquid assets such as property and private equity can trade at big discounts to (potentially stale) valuations. Funds such as the Fisher Funds typically trade at a discount of up to -6%, at which point the fund begins repurchasing its shares.
High-quality funds like AFI, the ASX's largest, have historically traded at a premium to NTA (Net Tangible Assets), suggesting investor confidence in the manager's long-term performance and ability to navigate market volatility.
Since Covid, the level of discounts across LICs has widened, with some of Australia's largest LICs trading at discounts close to -25% as of 31 January. The small-cap funds have fared worse, seeing discounts as high as -34%. On average, the LIC market is trading at a discount of -9.3%.
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HISTORICALLY, purchasing quality LICs at a discount has been a favoured strategy among shrewd investors seeking value opportunities. Discounts can enhance yields for income-focused investors and offer opportunities for supercharged returns should the discount be narrowed over time.
However, investors should exercise caution as discounts on LICs may indicate underlying issues, such as poor management performance, portfolio quality concerns, or low liquidity in investments. It is not as simple as seeking out the biggest discount, as there are often valid reasons behind an LIC's discount, from which they may never recover.
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FACED with a discount, investment managers can employ various strategies to close the gap driven by poor performance, market concerns, liquidity constraints, and changes to dividend policies. These discounts can hinder the growth of LICs, prompting managers to implement tools to bridge the gap and improve the health of their business.
One strategy is share buybacks, where LICs repurchase their shares from the market to reduce the number of shares outstanding, thereby increasing the share price relative to NTA.
Another strategy is to provide consistent and growing dividend payments. LICs with stable and growing dividends signal strength in the manager's ability to sustain these payments over the long term and are compelling to income-seeking investors.
Increasingly, managers are considering converting LICs to unlisted and open-ended funds. This structural change can help delist the LIC and convert it into a fund that is not traded on the stock exchange, potentially addressing the discount issue.
The closure of funds within LICs can reflect poorly on the manager, increasingly prompting a role of activism among investors. As shareholders become more assertive in their demands for transparency and performance, the closure of funds signifies a lack of alignment with investor interests and the failure to deliver as promised. This trend highlights a growing emphasis on accountability and the need for LIC managers to demonstrate value and performance that aligns with investor expectations.
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ONE other notable development post-Covid is the removal of adviser incentives, particularly in recommending LICs. This move aims to eliminate commission-based compensation structures which had historically been a key part of marketing LICs.
For LICs, the ‘new’ challenge is to maintain their appeal to investors and advisers without the leverage of sales commissions. Some have the ability to demonstrate the value of their offerings, such as their investment strategy, performance track record, and the quality of their management teams. Others don’t have such advantages to fall back on.
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LOOKING ahead, LICs face significant challenges in the investment landscape, partly due to the emergence of alternatives better suited to modern investor needs and partly due to an overabundance of fund openings leading to industry consolidation.
Poorly governed strategies that fail to serve investor interests or deliver as promised are being scrutinised, leading to discounts, closures, and restructuring. However, there remains a place for active funds that are well-managed and aligned with investor interests, provided they can fulfil their promise of easy access and solid returns.
The shift in Australia towards greater accountability and efficiency is a positive development, underscoring the evolving nature of the investment industry and the importance of meeting investor expectations in a competitive market. It is hoped that similar improvements will be seen in New Zealand's local options.
Investors interested in adding Listed Investment Company exposure to their portfolio, or reviewing existing holdings, are encouraged to chat with one of our advisers.
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Travel Dates
Our advisors will be in the following locations on the dates below:
20 March – Christchurch – Johnny Lee (FULL)
21 March – Napier – Edward Lee
22 March – Napier – Edward Lee
25 March – Palmerston North – David Colman
10 April – Auckland (Ellerslie) – Edward Lee
11 April – Auckland (Albany) – Edward Lee
12 April – Auckland (CBD) – Edward Lee
18 April – Tauranga – Johnny Lee
19 April – Hamilton – Johnny Lee
Fraser Hunter
Chris Lee & Partners Ltd
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