September 28, 2007

	Why L-I-Cs can be D-U-Ds By Scott Francis

• 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.

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.

Conclusion

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.