When it comes to launching an investment vehicle, the closed-ended structure of listed investment companies and trusts (LIC/LITs) has a storied history of over 100 years.
Offering firms the option to list their vehicle as a company or a trust on the stockmarket, they are a way for them to raise money via an initial public offering (IPO) and then trade on the public market like a stock.
For decades, this has allowed firms to run strategies with a longer time period, to trade at a premium or discount and pay dividends to shareholders.
But it seems like the tide is turning for these strategies as, in the past six months, Magellan, Antipodes and Monash have all opted to exit the closed-ended structure in favour of an open-ended option.
Magellan is seeking to transition its Magellan High Conviction trust to an active exchange traded fund (ETF), Antipodes is looking to merge its Global Investment Company (APL) into its open-ended Global fund, and Monash moved its Absolute Investment Company into an exchange traded managed fund (ETMF) earlier this year.
For all three vehicles, they said the decision had been taken as it had been a struggle to close the discount that developed on the products despite repeated efforts and that a move was in the interest of the clients.
PROBLEMS WITH LIC/LITS
The main problems cited by the firms were the inability to close the discount and the liquidity.
Unlike open-ended vehicles, liquidity in LIC/LITs is fuelled by existing shareholders buying and selling shares and it dried up during the market volatility surrounding
COVID-19 last year. Smaller LIC/LITs or those in a niche area would likely have less liquidity and this meant investors could be unable to sell at the price they would like.
Meanwhile, trading at a discount to net tangible assets (NTA) occurred when the trust or company was unable to raise capital and growth was stunted. This could be caused by a variety of factors such as poor performance, lack of dividends or insufficient communication with shareholders.
A persistent discount indicated the strategy was out of favour with investors and, again, made it difficult for investors to sell at their desired price.
Craig Wright, head of governance and advisory at Magellan, said people had been selling units in its High Conviction Trust in light of last year’s market volatility which meant there was more supply available than demand.
“Because of COVID-19, people were selling because of the volatility and there was more demand than supply so the discount never bounced back,” Wright said.
“We listed in 2019 and then it suffered issues because of COVID-19 which knocked confidence and it went to a large discount. We were worried about this perpetuating and investors thinking the discount would never go away.”
Monash director, Simon Shields, said the firm had realised it was a mistake to opt for the LIC structure two years after it listed in 2016 as the vehicle was trading at a discount.
“Within two years after listing, we felt it reflected badly on us as portfolio managers,” Shields said.
“We had come from established fund managers and we felt it was besmirching to be running an LIC that was trading at a discount.”
Other risks of LIC/LITs, according to the Australian Securities Exchange (ASX), included manager risks, regulatory or tax risks which might affect its tax treatment or share value, foreign investment risk, derivatives risk or fund-specific risk if the LIC/LIT used borrowing or leverage.
Angus Gluskie, chair of the Listed Investment Company and Trusts Association (LICAT) said there were numerous options available for companies and trusts trying to close the discount.
Reasons, he said, for firms encountering problems with a persistent discount included the general ebb and flow of the market, if an asset class was out of favour, if the management costs were too high or if it was unable to attract new investors.
“If the discount is due to cyclical factors or market movement then investors need to be able to digest that and it can present opportunities for investors to buy shares cheaply,” Gluskie said.
“But if there is a large discount then it is important to resolve that. They need to work out why there is this mismatch, look at the cause of that and how they can remediate it. This could be to buyback stock, provide capital returns or improve their shareholder communication.”
But firms say they tried multiple options to no avail.
For Antipodes, an ASX statement said the company tried an on-market buyback offer, among various options.
“APL’s board has over the past two plus years been actively considering a range of options to address the unacceptable position of the APL share price trading at a discount to its NTA,” it said. “Initiatives undertaken included an accelerated on-market buyback programme, enhanced shareholder communication and a conditional tender offer approved by shareholders in November 2020 Nevertheless, the discount has persisted.”
This was echoed by Wright who said Magellan had enacted regular shareholder communication, more frequently than was required by the ASX, to help them understand its value as well give them certainty about distributions.
Gluskie said: “If it is a permanent mismatch then they will need a permanent solution where another company takes it over, they merge with another or they wind it up or return the capital to shareholders”.
However, even once the decision had been taken to change the structure, this was not necessarily easy to action for a company as Monash said it took the firm three years to change its structure, although this was partly delayed due to a regulatory review by the Australian Securities and Investments Commission (ASIC).
For trusts, as in the Magellan High Conviction Trust, Wright said the process was simpler and expected to take around two months.
“The board took the view that it was in the interest of shareholders to transition the trust to an open-ended vehicle which would reduce the discount. Moving from a LIT to an ETF was easy as we just delist the LIT and re-list it as an ETF.”
Since transitioning, Shields said Monash felt it had been a good move which had contributed positively to its clients.
“It has been a really good move, we had various aims which was to remove the discount, solve the liquidity issue and pay a quarterly distribution of 1.5%,” Shields said.
“The big problem we wanted to solve was the discount relative to the NTA and the challenge of liquidity which was putting people off and these have been fixed. The distribution was something we were thinking about doing but it wasn’t the main reason.”
IS LIC/LIT STILL A VIABLE STRUCTURE?
Having been around since the 1900s, LIC/LITs had an esteemed history and the largest one, The Australian Foundation Investment Company, had been around since 1928 and had over $9 billion in assets under management.
Gluskie said LIC/LITs had their benefits but were unsuitable for investors with short-term time horizons, firms operating niche strategies or unstable investment strategies as this could result in dramatic shifts in buying or selling.
“Firms have to assess if a LIC/LIT is appropriate for that asset or the investor they are targeting, it is important to choose the right structure and maybe it was the wrong one for those which have now converted,” he said.
“If you have a long-term mindset then it can create opportunities for investors.
“Companies should have that longevity to be able to understand the liquidity mismatch and need to be prepared to run with that.”
Adam Myers, head of distribution at Pengana, said the firm was happy with its International Equities LIC.
“We are very satisfied with the structure and have not had any unhappiness, it has been good for our investors.”
Wright said he still thought LIC/LITs were a good vehicle as they provided access to strategies that would not normally be accessible but firms needed to consider if they were appropriate for their chosen strategy.
Gluskie acknowledged there had been a downturn in the number of LIC/LITs launched in the last three years but attributed this to the unusual COVID-19 market conditions and the political debate about franking credits which occurred in the last Federal election.
The sector was $58 billion in size at the end of June 2021, and $36 billion of this was invested in Australian equities and $16.5 billion in global equities. The remainder was held in fixed income LIC/LITs.
But, according to BetaShares, since the abolition of commission paid to brokers by LIC sponsors in May 2020, there had been a net reduction of 10 LICs a year later and the firm said this was indicative of growth being tied to broker remuneration.
Shields said: “LICs were the old way of doing things, they tended to be pushed by stockbrokers who would get fees from the IPOs.
“I don’t think we will see the market go back to them, I wonder why people would run funds in any other way [to open-ended].”
