The other side to the older, low fee LICs.

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.

 

AFI

“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?

 

ARG

“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.

 

BKI

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.

afi perf.jpg

ARG – some minor underperformance on the 10-year number.

arg perf.jpg

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.

bki perf.jpg

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.

AFI

afi nta.jpg

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.

 

Final thoughts.

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.

Advertisements

23 thoughts on “The other side to the older, low fee LICs.”

  1. Steve,
    A thoughtful article. A couple of contrarian points I would like to add.
    + When business decisions are primarily influenced by taxation, one does not sell when they should sell and then they are inclined stick to the poor decision because of confirmation bias.
    + When you look at the accounts of these LICs they have already set aside the funds for the tax payable, so the difference is the investment return on the cash payable to the ATO. In a typical investment year, this would affect returns by a once off 0.5% which should be more than offset by investment losses avoided. On the plus side the cost base of the investment portfolio has risen and the capacity to pay franked credits enhanced.
    + My personal preference is to focus on LICs that focus on best decision of the day/week/month/year because they are consistently out-performing these old (style/money) LICs

    1. Hi James,

      Yes I wonder if there are a few cases where they held off selling a stock for tax reasons, and then watched it underperform. Hard to say to for us outsiders.

      I also wonder if they have identified some trades to add value, but implementing them due to their size has constrained them. I don’t have a good feel for this.

      Then have they built up a fear of underperforming the ETFs and become a bit gun shy to trade as much?

      Cheers
      Steve

  2. Hi Steve,

    I think that your final comment about these grandfathers of LIC being an approach to a regular investing plan is on the money, These LICs were mainly developed when there was not much a way to get easy access to a broad number of stocks on the ASX (‘diversity!’ 😉 ).You might think of them as the original ETFs (with some ‘active’ management) before there were ETFs. Given their size, yes you are right – they couldn’t meaningfully trade actively too much without moving the market so in some ways you can only tweak around the edges.

    Ex-50 or ex-20 based simple LICs would certainly give you more diversity than the somewhat top heavy LICs that you mentioned but having an assurety of a fatter dividend has always been the allure of the grandfathers regardless of the capital growth (or decline) of the fund. I guess that it is hard to be all things to all people.

    Keep up the good work!

    1. I agree Eddster probably what is putting off more LICs to start up ones that are more of an ex top 20 style fund is it will sacrifice some of the higher underlying yield.

      However in the medium term if it ultimately generates better growth then that can also play a role in supporting a good dividend.

  3. Hi Steve. We tend to agree. The reluctance of these funds to realize gains on their investments risks them becoming too heavily exposed to ‘yesterday’s winners’… the big banks being the clear example of this. We took a look at all of the old LICs last year and their 10 year performance give or take a bit is pretty much in line with the benchmarks.

    http://www.etfwatch.com.au/blog/how-do-the-grandfathers-of-australian-lics-compare

    Regarding their NTA, I suspect publications like the barefoot investor help keep Argo and AFIC’s share price high. He promotes them and his members blindly follow his recommendations. At a premium to NTA I’d Rather stick to ETFs that track the index, but at a discount these LICs may be a nice index alternative.

    Like you, we’d love to see some 50bp funds pop up that offer low turnover but more diversification away from the index.

    1. Agree with your thoughts there Etfwatch.

      I do think some of the financial media need to more accurately describe them. The barefoot investor does some great work and I think it is generally a good thing many people follow this thoughts and read his book. I did observe though that the articles I saw on his site for AFI and ARG mention about getting exposure to 100 or so of Australia’s top businesses. I just wonder whether a small punter without much share market experience knows that could mean 30% in financials from those words? About a quarter in four banks that are quite correlated.

      The LICs themselves are still not shy in using terms like diversified and active.

      Inexperienced investors may think they are getting professionals that have skills in picking the best companies from the worst. The evidence is starting to look a little mixed. Granted the MER is dirt cheap. But management create a fair bit of wealth for themselves even though the performance record is looking relatively average.

  4. I use the old LIC’s like others use cash and bonds in their portfolio. I like them as a great source of fully franked divvies, pretty reliable div payments despite what the stock market is doing. It all depends on what you are expecting out of them. My expectations are quite low.

    1. If you understand how they are run and what’s inside of them I can still understand the attraction of using them.

      It is a lot about expectations and I am sure many like yourself Phil have a good understanding of them and their capabilities.

      I was just a bit surprised at when I saw their websites speak of active and diversified. For those starting out this could create the wrong impression.

  5. Don’t follow AFI and ARG as they have never traded at the large discount to NTA that I require for existing LICs, so no comments there. Did, however, became a BKI shareholder when they took over Ian Huntley’s HIC, which we acquired at a very large discount to NTA, Equivalent BKI entry price is less than half the current market price. I would have sold these long ago, but they are held in my still working wife’s name, so there is a CGT issue.

    About the best I can say about BKI is that they have low management fees. As they should be. Despite the rhetoric in their monthly reports (which never change – read one you’ve read them all), they are an extremely passive manager. For instance, despite the rise and fall of the mining boom, the number of BHP shares held stayed basically the same. And the last time I looked nine of their top ten holdings were in the top ten by market cap stocks. That the one they didn’t hold was CSL should not come as any surprise. To sum up:- Nothing happening here!

    1. Very interesting feedback there given the long history in keeping an eye on them.

      They are not sounding like a very active manager!

      These three LICs seem to rely on a brand that they are trust worthy based on long histories. I think they need to be careful therefore when describing their own investment approach that they are true to what they say.

      Another strength of their brand is low fees. They also need to be careful. Firstly ETF fees are getting more competitive. Secondly in the case of BKI and ARG they have played around with some other ventures. I.e. New associated LICs in URB & ALI, which may confuse their low fee branding.

      1. As an example of working “outside of one’s expertise”, URB shows that you need to have a good narrative that people can understand. 1/2 Urban Development and 1/2 equities to support the urban development until it gets legs? A strange mutant and the market did not understand it and the under subscription level showed it. I have never been a fan of BKI for exactly what Graeme says – very little change in the portfolio and very average performance. The spin off of the BKI investment advice into a separate company (ostensibly to manage URB apparently) is another piece of confusion when having the investment advice kept in-house is another point of brand dilution.

        Regarding this and the afore mentioned grandfathers, low fees are one thing but you are getting what you pay for here. The only advantage over an equivalent ETF might be dividend reserves.

  6. Eddster, I did not invest in URB for the simple reason the market would become bored with it because they have very little to announce for months on end. Dividends will be meagre, property valuations annually if you are lucky. Yawwwwn! It will make BKI look exciting.

    1. I would add that when I read the fine print of the fees of URB, the property side didn’t look that simple. Seemed like the manager had lots of room to charge a variety of different fees on transactions.

    2. Good call. I am not sure how much they could have done with the urban development without a pretty large amount of capital (more than they raised). It tends to be a pretty expensive undertaking. I am not sure what they could redevelop with the money that they received (I am not following them admittedly). Somewhat like what Blue Sky faced… hmm

  7. this is a very perceptive article , i see banks are a very big lagger today (april 26th) and AMP came a shocker recently too…

    1. I saw for example that AFIC held plenty of AMP.

      Whether AMP and the banks perform well from this point of time is one question. The issue I have is whether a holding like AMP matches well with the snippet from the AFIC investment philosophy I noted in the post. Even prior to the RC, was AMP a company with a strong brand and high quality assets that can sustain superior returns over the long term?

      1. I heard Jason Beddow (arg.ax) speak recently where he advised they are required to keep their portfolio churn under 5% if they wish to retain their LIC discount on capital gains. Whilst welcome, the benefit is not significant. Just another constraint on their investment performance?

  8. Seems like BKI are keen to avoid selling existing holdings to take advantage of new opportunities. Big capital raising today to get some cash to use for their active and high conviction investment strategies. Seems like an unorthodox way of capital management.

    1. “Active and high conviction investment strategies” ? I’d think more the SPP ‘proceeds used for’ motherhood statement of increased liquidity, lower MER and investing in profitable, income producing, well managed companies. I actually don’t think liquidity is a problem for BKI, wonder how long it takes for the lower MER to cover the costs of the issue and am yet to see a LIC aiming to invest in unprofitable poorly managed companies.

      BKI have these SPPs every couple of years. Taxing the memory, but I seem to recall that the purchase price, post tax NTA and market price usually end up about the same. At least it isn’t diluting. I guess if one really want more shares in an increasingly under performing LIC, then going via the SPP may save one a few dollars in brokerage.

  9. Hi Steve,

    Just checking out your article again seeing I referred to it on PC forum. In regard to the following:

    “Like you, we’d love to see some 50bp funds pop up that offer low turnover but more diversification away from the index.”

    Of course Mirrabooka although Ex50 only is an alternative albeit with MER a little higher than 50bp. And often overlooked is Amcil (large and small cap) with similar MER to MIR.

    For a number of reasons I’ve been simplifying our portfolios. Probably summed up as simply: Buy an older LIC when cheap, Index ETF if not. At this stage of life and being a dividend focused investor that’s all that’s really needed for us. Add to that a generous cash buffer for any potential dividend shortfall in times of gloom I’m confident we won’t find ourselves sleeping under a bridge and eating cat food🙂.

    Cheers

    1. No worries Nodrog. Thanks for bringing up examples of Mirrabooka & Amcil. I probably know less about them than most because I haven’t had them much on my radar. I might try and look a bit more at these and others in this slightly more expensive than the older brigade category. Any others worth a mention?

      My article probably appears quite gloomy on the old LICs and no doubt has a negative tone. But can can still see the attraction. Especially with those that are financially quite secure. Meb Faber on his podcasts refers to this as you have already won the investing game. So no need to try anything fancy if a modest stable dividend yield covers your living costs. I thought my article may perhaps give some younger less experienced investors some food for thought. I have seen the very inexperienced viewing these LICs as diversified enough to put all your eggs in this basket. There are risks though the growth may not meet those investor’s higher return goals like for example the last decade.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s