Investors face new choices in listed vehicles

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The market capitalisation of listed investment companies (LICs) and listed investment trusts (LITs) on the ASX reached almost $35 billion in July 2017, up 12% from the previous year. What is driving the interest and what are the fundamental differences between these structures?

LICs and LITs popularity boost

While LICs have traded on the ASX for nearly 100 years, it is only relatively recently that a wide range of investors have taken advantage of their benefits, spurred on by regulatory changes and market conditions.

One of the key factors driving the increased interest was the introduction of the Future of Financial Advice (FoFA) legislation in 2013. FoFA abolished the generous upfront trail and soft commission structures that had, until then, been enjoyed by advisers who recommended their clients into managed fund products. This directly resulted in an uplift in appetite from investment managers, financial advisers and investors in using LICs.

The number of LICs listed on the ASX now exceeds 100, double that of five years ago. While many people are familiar with LICs, LITs are less well known and less common in the Australian market.

So, what is the difference between LICs and LITs and what does it mean for investors?

LICs and LITs give exposure to a broad range of assets in one transaction. Both are traded on the ASX, which is appealing to a lot of self-directed and SMSF trustees.

Unlike a managed fund, however, their assets are held in a closed pool, which means they usually don’t issue new shares or cancel existing shares as investors join or leave. If investors want to exit, they have to sell their shares (or units) on the stock exchange. They can’t be redeemed.

Differences between LITs and LICs

The biggest difference between LICs and LITs lies in the way they are structured. A LIC is a company, which pays dividends to investors, whereas LITs are incorporated as trusts and must pay out any surplus income to investors in the form of distributions.

Some of the fundamental differences include:

Tax transparency

A LIC treats the dividends from underlying investments and capital gains as income on its profit and loss statement. The LIC then deducts operating costs to derive a profit before tax figure. This is then taxed at the company rate before dividends are paid.

By contrast, a LIT more closely represents an unlisted managed fund in that all net income and realised capital gains must be distributed on a pre-tax basis, and the end investor pays any taxation.

Capital gains tax treatment

A major advantage of the way LITs are taxed is most individual investors will be eligible for discounted capital gains tax concessions applicable to investments held for more than 12 months.

Corporate entities are generally not eligible for this discount, although some LICs may qualify for a concession from the Australian Tax Office to pass on this benefit to shareholders.

Ability to pass through income can lead to predictable returns

A LIT may also provide the manager with more flexibility in paying distributions, allowing them to pay out more than the underlying income levels, through a return of capital. This can be useful when the manager wants to pay out a set portion of the fund each year, to give investors a predictable income stream.

By comparison, a LIC is limited by its ability to pay dividends, requiring the accumulation of retained profits before a dividend can be paid.

With an ageing demographic of investors who will be increasingly focused on income, it is likely that more LITs will come to the market as more investors grow to understand the structure of these products and realise their advantages.

Whether investors choose to invest in a LIC or a LIT, or both, it is highly likely the growth of the market is set to continue.

 

Andrew Lockhart is a Managing Partner at Metrics Credit Partners (MCP), an Australian debt-specialist fund manager. MCP is offering investors exposure to the corporate loan market through the MCP Master Income Trust, which will list on the ASX soon. This article is general information and does not consider the circumstances of any investor.

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5 Responses to Investors face new choices in listed vehicles

  1. Gary M September 14, 2017 at 12:35 AM #

    But FOFA didn’t outlaw sales commissions (sorry ‘handling fees’) that LICs rely on to get sold, which is driving demand for listed securities. Let’s not pretend FOFA addressed these conflicts. Also, would be interesting to read about differences between LITs and unlisted managed funds.

  2. John Wilson September 14, 2017 at 4:54 PM #

    I agree LIC dividends are post tax, whereas LITs are pre-tax and so investors are able to take advantage of their personal or super fund CGT discounts. But so what? Surely that’s evened out by the franking on the LIC dividend?

  3. Stan September 14, 2017 at 7:33 PM #

    It is hard to imagine that the loss of commissions from unlisted funds caused financial advisers to move away from them towards recommending LIC’s to their clients. I thought that they always had their clients best interest in mind ?

  4. Craig September 18, 2017 at 3:45 PM #

    Thanks for the interesting article. I would like to put forward 2 questions:

    1. “Some LIC’s may qualify for discounted CGT tax concessions”. Why some and not all, which (I understand AFIC does) and how?

    2. How does the return of capital in a LIT work?

    Thanks

  5. Adrian September 19, 2017 at 10:19 PM #

    1. it’s mainly the old school, traditional LIC’s that qualify to pass through the CGT discount. Need turnover < 10%, infrequent sales, etc. Refer here… http://www.finsia.com/docs/default-source/jassa-new/jassa-2006/2_2006_tax_tr2005_23.pdf

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