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Why L-I-Cs can be D-U-Ds - Eureka Report Article

September 28, 2007
Why L-I-Cs can be D-U-Ds
By Scott Francis

PORTFOLIO POINT: Buying a share of a listed investment company offers "instant diversification". That's where the advantage ends.

Here at Eureka Report we take a hard line on lazy fund managers: Listed investment companies (LICs), on the other hand, have got away very lightly. Those big names - Argo, AFIC, Choiselu, Milton - we've doffed our hats to their eminence and sterling track records.

But today we blow the lid on LICs. Following a series of requests from subscribers who wanted to see LICs examined independently, our exclusive Eureka Report survey will prompt all investors to see LICs in a new light. Yes, they do well, but they don't do as well as the market. In fact on average LICs do not match the market; worse still, the bigger the LIC the worse it gets.

What is a listed investment company?

Let's start with the basics. LICs are companies, listed on the Australian Stock Exchange, carrying on the business of managing an investment portfolio. Investing in a LIC means that you become part-owner of the underlying investment portfolio, and the investment manager's skill. Among the biggest and best-known LICs are the JB Were-linked Australian Foundation Investments, Rob Patterson's Argo Investments, and Choiseul and Milton, two LICs associated with veteran investment manager Robert Millner.

Being able to become a part-owner of an investment portfolio by purchasing just one listed investment means LICs are a great source of "instant diversification".

LICs can represent some of the cheapest managed investments available. For example Argo, a long-established listed investment company that manages an Australian share portfolio, has a management fee of 0.15% of the companies portfolio. This is less than a tenth of the average retail managed fund fee of just over 1.8%!

Understanding the net tangible assets of an LIC is important to understanding how LICs work. The net tangible assets of an LIC are the value of the investment portfolio on a per share basis. For example, Argo investments, a large listed investment company reported its net tangible assets (the value of the underlying investment portfolio) as being $8.07 per share at the end of August 2007. Translated, this means that investors buying Argo shares - trading at about $8.02 - were buying an investment portfolio with a value of $8.07 per share.

Why might we expect LICs to outperform managed funds?

My expectations prior to putting together the results for this study were that listed investment companies (LICs) should outperform the large retail managed funds we looked at in our recent managed fund survey. I think that a lot of educated investors also see LICs as more sophisticated investments that are likely to outperform the large managed funds. I would offer three reasons for this perceived sophistication and expected outperformance:
  • Fees. Many listed investment companies, particularly the older, larger listed investment companies have significantly lower fees than the large retail managed funds in our managed fund survey.
  • Lower levels of trading. Managed funds issue and redeem units every trading day. This means fund managers are constantly buying and selling shares in the managed fund to meet the cash flow needs of additional contributions to managed funds, or withdrawals from managed funds. Studies have estimated that this accounts for up to 70% of the overall trading in managed funds. LICs, on the other hand are not constantly issuing or redeeming shares on a daily basis; the number of shares stays relatively constant (except if there is an occasional rights issue or buy back of shares). This means that the portfolio trading happening in an LIC is strategic, whereas in a retail managed fund it is both strategic and to meet the need for units being issued and redeemed.
  • Low Marketing Costs. Retail managed funds are always looking for new investors, to increase the size of the fund and therefore the fees from the fund. Therefore, there are marketing activities and costs to support this. LICs don't regularly issue more shares, and have less need to pay for these marketing activities.

The results

Unfortunately despite the skill, experience, low fees, low markeintg costs enjoyed by LICs our survey found most LICs dissappoint most of the time - that is they do not achieve the basic ambition of 'beating the market'. Moreover, the best known and biggest funds are even less likely to outperform - only the funds highlighted in yellow have actually outperformed the ASX 300 accumulation index.

nHow the LICs performed *
Returns to end of June, 2007
Size ($m)
12-mth return
5 Year Av Anual Return
ASX300 Index Return (accumulation)
Aberdeen (ALR)
Amcil (AMH)
Argo Investments (ARG)
Australian Foundation (AFI)
Aust. United Investments (AUI)
Carlton Investments (CIN)
Choiseul Investments (CHO)
Diversified United Investments (DUI)
Djerriwarrh Investments (DJW)
Huntley Investment Company (HIC)
Hyperion Flagship Investments(HIP)
Milton Corporation (MLT)
Sylvastate (SYL)
WAM Capital (WAM)
Whitefield (WHF)
Average Out/Underperformance
- 5.22%
- 1.58%
Size Weighted Out/Underperformance
* Outperformance of the ASX300 Accumulation Index is marked in yellow

How did we construct our sample?

A key question in looking at LIC performance is: do we use the change in the net tangible assets of an LIC over time as the measure of performance, or do we use the actual returns to investors from owning the LICs as the measure of performance? The change in net tangible assets of an LIC might be different from the performance an investor in an LIC receives, because LICs can trade at a discount or a premium to their net tangible assets over time.

Looking at the change in net tangible assets would give the most precise measure of fund manager performance, whereas looking at the actual results from owning LICs provides the most accurate description of the returns the investor actually receives. In this case the survey has been based on the returns the investor receives. After all, the return that they receive is all that really matters to an investor.

The sample is all the listed investment companies that invest in large Australian shares that have at least a five-year performance history. The source of this data is the ASX website, which produces a summary that includes one, three, and five-year listed investment company returns. Of the 18 Australian LICs in this table with five-year returns, three were excluded.

. Ironbark Capital, which had particularly poor returns, was excluded because it invested in a combination of Australian shares and fixed interest investments, and it was not fair to compare it against the return from just Australian shares.

. Mirrabooka Investments, an LIC with strong returns, was excluded because it invested in small and medium-sized companies, and its return should be examined against a small/medium company index, not a large company index.

. New Privateer was excluded because it issued a product disclosure statement early this year that suggested its activities are very different from a large-company LIC.

This leaves us with 15 LICs to compare against the ASX 300 accumulation index return. The ASX 300 accumulation index measures the average total return (dividends and capital growth) from the largest 300 listed companies.


The results speak for themselves. The experience of investors in large Australian share LICs has not seen them capture their fair share of the extraordinary investment returns that have been on offer over both one and five-year periods.

LICs allegedly trade at a discount to their net tangible assets during strong market conditions, and a premium during poor market returns. I should add that I have never seen any compelling long-term proof of this theory. It could, however, explain some of the underperformance during a period of extraordinary strong sharemarket returns.

Even if that was the case, it does not change the fact that the average investor in a large Australian LIC has had an investment experience that has not kept pace with the average sharemarket return as measured by the ASX 300 index.