The positives of the older, low fee LICs I feel are very well known and covered. I personally think they have been excellent investment products for so many for such a long time. I particularly like the positive influence they have had on investors helping them with the behavioural aspects. i.e. sticking the course and seeing the benefits of compounding, highlighting dividend returns and benefits from not overtrading, including taxation benefits.
Now for the section where I might receive some negative feedback!
I shall touch on some potential headwinds. Hopefully readers understand my objective of the post. I thought perhaps for younger investors that it would be useful to consider a few other aspects. Occasionally I read some presenting these LICs as almost a one stop shop to instantly get the only portfolio you need for the long term. I just want those considering using them as a very large part of their portfolio over the next few decades to be mindful of all the potential issues. Some may still be tempting to taking this approach, after all it has worked ok for many decades in the past. I am not long or short these stocks, so I personally am not that fussed how they perform from here.
For this blog post I have picked out a few of the large ones, AFI ARG & BKI.
How do they sell themselves?
Firstly, I wanted to touch on how they represent themselves. I am going to copy and paste some material I found on their respective websites.
I am wondering if some of the material was very relevant a decade or two ago but is now becoming a little stale.
“AFIC focuses on investing in Australian companies with unique high quality assets, brands and/or business footprints that can withstand the business cycles. Our view is that such businesses will generate superior returns over the long term.”
My comments – I am about to regularly mention the percentage in banks held by these LICs. I am not necessarily saying banks will be poor performers, just questioning how this fits in with their stated investment philosophies. For example, did AFI arrive at their 22.5% position in the four major banks because of the above investment philosophy? Do they still view them as generating superior returns over the long term, like they may have 20 years ago? Arguably the answer could be yes. They may also understand that selling down any of these holdings would generate plenty of tax payable. This would eventually reduce the before tax NTA, and the share price often trades close to this measure. It would also produce a more active underweight position versus the index. That would increase performance risk. Would they want to take more of this risk given they already have a good reputation versus ETFs, and some taxation advantages versus their competition?
“Our investment objective is to maximise long-term returns to shareholders through a balance of capital and dividend growth. In order to achieve this, a diversified portfolio of around 100 holdings has been constructed. The portfolio is deliberately conservative, with the 20 largest ‘blue chip’ holdings making up more than 60% of the value of the portfolio and providing over 60% of the dividend income. Smaller companies are also held, where we see potential for long-term growth and increasing dividends.”
My comments – In the portfolio allocation section of the website they had 31% of the portfolio classified under the banks & other financials sectors. I think the term diversified portfolio sometimes gets applied too loosely.
The objective of long term returns via a balance of capital and dividend growth is fine to have. The ten year performance numbers is a period that is not exactly short term. The portfolio return of 5.3% indicates the balance of returns are strongly skewed to dividends rather than any meaningful capital growth. Sure, this period includes the GFC. Yet is also includes more or less a 9 year global bull market in equities.
“The BKI portfolio is benchmark unaware and has no specific sector or stock investment limitations. BKI has the ability to have overweight or underweight positions in certain stocks or sectors.”
“Active, high conviction, no debt.”
My comments – I just find it strange that with more than 26% of the portfolio in the major banks, we can describe them as benchmark unaware, active & high conviction.
I would be more comfortable if their stated philosophies read a little differently. Perhaps something along the lines of “After considering our tax payable if we were to sell positions, and the constituents in the ASX200 benchmark, we formulate an optimal portfolio. These factors may limit the overall sector diversification of the portfolio. We aim to achieve modest outperformance of against the benchmark after fees, with little risk of substantial deviations from benchmark returns.”
OK sure, I probably won’t get a job working on a marketing blurb for these LICs.
Some issues to consider
1) Are the stocks in the portfolio being actively managed? Are they held because they have the brightest prospects?
2) Is the massive size of some LICs making them inflexible?
3) If they were biased to hold stocks for longer to avoid crystalizing tax payable, is that optimal for future performance prospects?
4) Does the historical performance look good? Is it becoming more difficult for them to generate alpha?
5) If they are biased to hold a portfolio similar to the ASX200 benchmark, will that also constrain their future absolute performance potential? Australia has a record breaking run with no recession. Despite this revenue growth from our large companies hasn’t been exciting in recent times.
These above questions I feel are getting more relevant to ask than they were a decade or two ago.
I can still see though how for some investors they may still have their place. With the current franking rules in place, you can mount an argument that they may be preferable to the ETFs on the ASX benchmark.
So much has been said about Labor’s franking plans, so this post would become far too long if I start incorporating the potential impacts here. I would just say that it would be an unwelcome change to these LICs IF it was introduced.
This blog post was in the back of my mind before all the political news on franking became front and centre in March.
In terms of the historical performance, I will include below some of the longer term numbers I recently found on their websites.
Historical Performance, quite possibly acceptable in most cases but…
AFI – Just bear in mind the share price returns in the light green have in some cases been assisted by positive re-ratings to the discount / premium to NTA.
They have achieved some minor outperformance with the NTA measure over the 10 year period.
ARG – some minor underperformance on the 10-year number.
BKI – Once again just be mindful that when looking at total shareholder returns. It may have included a tailwind in certain time periods from positive re-ratings of the discount / premium to NTA.
When considering portfolio outperformance v index numbers below it doesn’t come across is great stock picking.
Trading at a premium to pre-tax NTA.
I want to leave aside for the moment the potential impact of any franking changes that may or may not occur.
I have raised a few question marks with these LICs, and the answers may not necessarily be negative. It is quite subjective. I think that these sort of questions raised over time may be discussed and debated further, potentially leading to some doubts in some investor’s minds.
As I write all three seem to manage to trade at premiums to before tax NTA. So I think they have generally become more popular in recent years, during a time where I think the doubts and question marks may be increasing.
That seems a little at odds to me. I would expect that regardless of what happens to franking, they might struggle to retain the premium to before tax NTA in the longer term. In the last five years I get the sense investors are far more willing to embrace ETFs, but thus far the popularity of these LICs seems to be holding up well.
Below is a little perspective for AFI from their website, in terms of their historical discount / premium to NTA over the last decade.
What implications may some of the issues above have for future LIC products?
I wouldn’t be surprised if we see more LICs in the style of say PIC & QVE. They retain some of the qualities but offer more sector diversity and more actively managed. At the same time, they are patient long-term investors that still focus a lot on dividends. Please don’t take this as a recommendation as I don’t own these. I am more having a guess what sort of new products we may continue to see. Clearly the big difference is fees, with these two charging closer to 1% management fees. Whether these two can add value after fees over the long term is also debatable I guess.
Perhaps there is an opportunity for more LICs in between these types of fee structures. For example, charging a bit under 50bps, and start with a fresh portfolio with no embedded unrealised gains. Aim to achieve modest outperformance over fees, relatively low turnover whilst producing good dividends. Maybe this can be achieved with more sector diversification and flexibility than some of the older LICs?
Are we now about to see the Wilson “no frills” fund?! They have been trying everything else lately 😊. Geoff, I would be ok to fill a board position if you asked. The jobs for board positions on low turnover LICs look pretty comfy to me. It is tongue in cheek that Wilson would start that style of fund up but maybe there is a gap there for someone else.
Please don’t take any of the above as any sort of financial advice. I come back to the beginning of the article where I touched on some benefits they can have on the behavioural aspect to investing. Even though I am not that optimistic about where they will trade versus NTA, or the performance of the ASX from here, they still can be a reasonable option for plenty of investors. That is if they help an investor stick to a regular plan, the investor may be better off even if these LICs don’t set the world on fire with their stock picking.