Considering a listed vehicle
The listed investment company (LIC) and trust (LIT)sector contains some of the largest and most cost-efficient actively managed investment entities that can be accessed by retail investors in Australia with more than 700,000 individual investors in LICs and LITs.
Here we outline some of the key things financial advisers and investors need to know about this unique sector.
PROFESSIONAL INVESTMENT MANAGEMENT
At their most fundamental level LICs and LITs are professionally-managed investment entities which provide investors with the potential to receive the income and capital growth from the underlying investments.
As such they can give investors:
- Access to assets and asset classes that may not otherwise be available to a small private investor; and
- Exposure to differing investment management strategies and investment teams.
CLOSED-END STRUCTURE
A key feature of LICs and LITs is that they are closed-end investment entities that have a fixed capital base. A fixed capital base, means that:
A LIC or LIT raises capital in one block at a specified point of time (unlike open-ended managed funds that may raise capital via investor deposits continuously); and
Investors in LICs/LITs increase or decrease their investment by buying and selling shares in the LIC/LIT via the Australian Securities Exchange (ASX), rather than depositing/withdrawing moneys from the LIC/LIT.
A STRUCTURE SUITED TO LONGER-TERM INVESTING
In any well-functioning economy, it is vital to have investment structures that can provide long term investment funding. Property, fixed income, infrastructure, renewable energy, lending, and even general business investment all require longer-term capital.
Closed-end funds, with their fixed capital, are one of the few investment entities that are naturally suited to the funding of assets that require this longer-term investment horizon.
This is in contrast when open-ended funds invest in longer term assets, they may be forced to sell those investments in order to fund investor withdrawal requests. This would particularly be the case in weak and fearful markets.
TAX AND COST BENEFITS
A further potential benefit of the closed-end structure of LICs/LITs are tax and cost savings.
Open-ended managed funds and exchange traded funds (ETFs) must repeatedly buy and sell assets to match the continuous ebb and flow of investor deposits and withdrawals.
These repeated purchases and sales incur transaction costs and crystallise tax liabilities on gains.
Because they do not have to sell assets to fund periodic investor withdrawals, a LIC or LIT should incur fewer transactional costs (the costs of buying and selling the underlying investment assets) and may also realise capital gains for tax purposes less frequently than open-ended funds.
LIC and LIT investors are also less exposed to the risks faced by investors in open-ended funds, where the hidden, deferred tax liabilities of the fund become the burden of the residual ongoing investors following a period of large withdrawals by others.
TRANSPARENT VALUATION
By buying and selling shares and units in LICs and LITs on an exchange, investors transact at a price which takes account of all factors considered relevant. This may include asset backing, structural risks, benefits and opportunities, expectations, embedded tax liabilities or benefits or differing views on the value of underlying assets.
The price of a LIC or LIT determined in the open market on the ASX may be higher, lower or the same as the underlying net asset backing. This is referred to as trading at a premium or discount to asset backing.
The trading of LICs and LITs at premiums or discounts to net asset backing or value is a normal and important part of closed-ended fund operation and is the mechanism by which the net demand of buyers and net supply by sellers may be matched-up.
STABILITY BENEFITS
Because of their fixed capital, LICs and LITs are one of the few entities that can be a buyer of assets in weak and fearful markets. This has the important benefit of assisting in the stabilisation of investment markets.
In contrast, open-ended funds and ETFs typically receive net investor deposits, and must invest those moneys, during periods of market buoyancy in turn pushing market prices higher. Similarly, such funds typically receive net investor withdrawal requests during periods of fear and market weakness and accordingly they become a seller of their underlying assets which may push asset prices down further. In this way open-ended funds and ETFs are pro-cyclical investors with the consequence for investment markets that this may exacerbate market volatility.
CORPORATE GOVERNANCE DISCIPLINES FROM ASX LISTING
As ASX-listed entities, LICs and LITs must comply with the ASX Listing Rules. These listing rules contain important requirements designed to protect shareholders. They seek to promote transparent and timely disclosures of information that may be needed by investors and encourage high standards of corporate governance and oversight to be implemented.
The strength of these corporate governance protections may be one of the reasons why the ASX listed LIC & LIT sector contains several of Australia’s largest and oldest investment funds.
LOOKING AHEAD
LICs and LITs have been assisting investors in growing their wealth for nearly 100 years. The efficiency and stability of their closed-end structure coupled with the corporate governance disciplines of ASX listing have proven to be far more durable than many other investment structures.
As market conditions stabilise, the industry hopes that a further range of LICs and LITs will be brought to market, in turn providing investors with a continued expansion of investment choice.
Angus Gluskie is chair of Listed Investment Companies and Trusts Association.
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