During my many years in the investment industry, I have watched the ‘rivalry’ in Australia grow between unlisted managed funds and listed investment companies (LICs). One noticeable aspect is the dramatic increase in the number of LICs. Currently, there are 105 LICs on the ASX with a value of about $37 billion, a doubling since 2012. New LICs raised $3.5 billion in 2017 offering investors exposure to a range of asset classes, investment styles and markets.
With this growth, we should expect regular comparisons would be available on the performance of LICs over different time periods, particularly to gauge whether they are giving investors comparable or superior returns to unlisted managed funds. However, from my perspective, few LICs report performance in a manner that is fully transparent and relevant.
In my experience, unlisted managed funds regularly report performance over different time periods – usually for the most recent 1 month, 3 months, 6 months, 1 year, 2 years, 3 years, 5 years and since inception. And they report this performance net of all fees, which is the performance that directly accrues to investors.
By comparison, LICs usually report performance for single periods. In their monthly reports released via the ASX, they usually report their performance for that month. Then in their 6 monthly and yearly reports to investors, they usually report their performance for that half-year or year period, rather than for multiple past periods.
And the performance reported by LICs is usually only the performance of the underlying investment portfolio rather than for the LIC itself. Such results are of limited use as they do not provide the full story from the investor’s perspective.
Let’s unpack the LIC performance issue
The component parts of the performance of a LIC is best illustrated in the following table1:
|Gross portfolio performance2||x.xx%|
|Add back impact of tax paid to ATO on LIC earnings||+x.xx%|
|Less management fee||-x.xx%|
|Less performance fee (if applicable)||-x.xx%|
|Net portfolio performance||x.xx%|
|Less LIC costs3||-x.xx%|
|Add back dividends paid to shareholders4||+x.xx%|
|Dilutions/accretions from capital raisings5||±x.xx%|
|Total net performance comparable to unlisted managed funds||x.xx%|
1 The above table assumes the LIC has an external management contract rather than the assets being managed internally with its own staff.
2 This is after deducting trading costs such as brokerage (and stock loan fees and interest expense for short portfolios).
3 These include share registry, accounting/secretarial costs, audit, listing fees, directors’ fees etc.
4 Performance calculations of LICs need to be adjusted for dividends paid, as this is obviously a cash outflow from a LIC. This is no different to unlisted managed funds which adjust performance calculations for distributions paid to unitholders.
5 Where a LIC raises capital at a price above NTA it is accretive to existing shareholders. Where a LIC raises capital at a price below NTA it is dilutive to existing shareholders.
LICs and unlisted managed funds should report performance in a like-for-like manner. This means performance for both should be reported after all fees (to show the actual investor experience) and before tax.
There are two reasons to show performance before tax:
- Unlisted managed funds are generally not taxed as they are a ‘conduit’ vehicle, and
- There are different tax rates applying to different investors (e.g. 0%, 15%, 30%, 45% etc.) regardless of whether they invest via a LIC or unlisted managed fund.
Given LICs are companies, they pay company tax on their earnings. So, any performance calculations of LICs need to exclude the impact of such company tax paid.
How do you calculate LIC performance before tax payments?
Each month, most LICs report their NTA before tax (that is, their NTA excluding any tax liabilities or tax assets). However, whenever company tax is paid to the ATO by LICs this causes their NTA to fall by the amount of the tax. So, it is necessary to add back the impact of such tax payments to the movement in NTA to arrive at performance numbers which exclude tax. While this sounds easy in theory, the reality is that the bulk of LICs do not provide this information to the public.
Some LICs do report actual tax payments as a dollar amount in their monthly NTA releases. The raw data allows the performance calculation to be made, although investors will need a spreadsheet to work out performance after fees and before tax. It would be far easier if all LICs did the performance calculations and reported it as unlisted managed funds do.
Is there another way to measure LIC performance?
There is another way to measure the performance of LICs other than the movement in NTA adjusted for tax payments (as outlined above). It is the movement in the share price after taking into account dividend payments (which, because we want to measure performance on a pre-tax basis, need to be grossed up for franking credits paid).
The problem here is that LIC share prices are influenced by factors other than the NTA, such as demand for the stock, scarcity value, marketing initiatives, LIC size, sizable undistributed profits, franking credits, etc. The share price performance is not totally in the control of the LIC, and there is often a premium or discount to the NTA.
A further problem is this ignores the stored franking credits, being those generated from tax actually paid but which have not yet been paid out, although franking credits are of no use to shareholders unless they are paid out.
If share price and dividend data is all we have to work out LIC performance, then so be it, provided we put appropriate disclaimers around such numbers.
As an aside, I was recently bemused by a major research house that issued a positive report on a particular LIC, citing the manager’s strong alpha generation over the past few years. A closer look at the figures showed the research house had used share price performance during a period when the shares went to a considerable premium to their NTA … methinks they stuffed that one up!
The gold standard for LIC reporting
As stated, LICs usually only report the performance of their underlying investment portfolio rather than for the LIC itself, which can be misleading to investors. Why LICs persist with this reporting weakness is a mystery to me, and they must assess performance over different time periods.
The best of all worlds is for LICs to report performance in three ways, to suits everyone’s needs:
- From the perspective of the LIC company – the NTA performance, adjusted for dividend and tax payments, as described above
- From the perspective of the LIC investors – the performance of the listed securities on the ASX (adjusted for grossed up dividends paid)
- From the perspective of the LIC investment manager – the performance of the portfolio (after portfolio management expenses) which may provide a useful insight about the value adding abilities of the investment manager
I have often pondered why most LIC managers only report the portfolio performance rather than the LIC performance. Undoubtedly some would do this for ‘marketing’ reasons, to give the best spin possible on results announcements and in annual reports. And some would do this because the manager of the portfolio and the promoter of the LIC are often the same, and a manager is always most concerned with their investment performance.
Whatever the reasoning, I contend that an investor in a LIC is most interested (or should be most interested) in the performance of the LIC itself. It ultimately has the most bearing on the share price which in turn affects the investors own financial experience.
Chris Cuffe is Co-Founder of Cuffelinks, Founder and Portfolio Manager of the charitable trust, Third Link Growth Fund and Chairman of Australian Philanthropic Services. He was the previous Chairman of UniSuper and the CEO of the major managed funds provider, Colonial First State. He is also currently a non-executive independent director of three LICs. The views expressed are his own.
Scott Whiddett, Business Advisory and Assurance Partner at Pitcher Partners, has over 19 years’ experience auditing LICs and has provided valuable input and insights into this article.