Why most LIC performance reporting is inadequate

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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:

  1. Unlisted managed funds are generally not taxed as they are a ‘conduit’ vehicle, and
  2. 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.

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15 Responses to Why most LIC performance reporting is inadequate

  1. John McCarroll December 14, 2017 at 11:51 AM #

    Great article. Hopefully LIC managers respond to your recommendations.

  2. Ashley December 14, 2017 at 11:55 AM #

    I guess LIC managers would say that they have no control over the share price so they just report on the business (NAV, etc) – just like any other listed co.
    – with a LIC you are not buying a portfolio you are buying management skill in adding value (hopefully) – just like with any other listed company you are not buying a bunch of business assets you are buying management skill in extracting profits from them, etc.
    – so LIC managers report on what they can control.

    • Graham Hand December 14, 2017 at 4:49 PM #

      Hi Ashley, in the LIC space, the board and management can have some influence over the share price and its relationship to NTA. For example, they can take care issuing new capital at a discount to NTA to new investors and diluting existing shareholders. There are many cases of investors losing faith with the company due to poor capital management techniques.

      The company can also communicate well with shareholders and investors, explaining how the fund works so there are no surprises.

      Here at Cuffelinks, we hear from some LIC managers who want to raise their profile by writing thought leadership articles, while others we contact don’t realise the need to nurture their public image. This indifference is then often reflected in their discounted share prices, while the good communicators go to a premium.

      Perhaps even more than ‘normal’ companies, LICs can influence their share price.

  3. Garry B. December 14, 2017 at 2:42 PM #

    I find it annoying when franking credits are lumped in with everything else in determining nta, though they earn no income. They certainly are a potential asset, but I suspect the treatment is almost entirely a marketing exercise, and perhaps is meant to deliberately confuse the investors ability to ascertain the true nta. To me they are little different to tax losses, and an appropriate discount may be called for.
    I also dislike the practice of including the franking as part of the yield. It is not dishonest, but it looks like an overstatement/promotion. Share investors understand tax implications, and many of us are in different situations. Though to me “alpha” is a Greek letter, I question the apparent concept of applying charting to LIC’s. The price of individual LIC’s will be determined by nta, plus or minus a percentage depending on investors regard for individual managers relative abilities. Short term though are ways to fool many investors.

  4. Neil December 14, 2017 at 3:54 PM #

    Thanks Chris – a great article.

    To me it’s plain commonsense that I want to know how much money the LIC COMPANY has made after all costs but BEFORE tax.

    Franking credits should be included in the NTA because they are “money in the bank” that I expect to receive in the next one or two dividends. Potential buyers and sellers need to know exactly what they are buying or selling, and franking credits are part of the deal. Like Gary B however, I do prefer they be identified as they are not invested capital as such.

    I have raised this issue with the Chairman and CEO of one stable of LIC’s but as yet, to no avail. From the annual reports I have tried to deduce the performance of the LIC Companies exactly as you set out in your excellent example, but found it next to impossible.

    I shall certainly be forwarding your excellent article to them!!

  5. Tom December 14, 2017 at 3:55 PM #

    Some LICs are the masters of focusing on this mythical portfolio performance they like to pay performance fees from. Not what you get as a shareholders. They show performance from some cherry picked “fully invested” date, which is arbitrary as they still holds cash today. Need to stamp this out. The NTA performance is way under portfolio performance given option exercise dilution, but portfolio performance fees are paid on the enlarged base.

    Investors – Look out for a couple of high profile LICs on their way, but returns stated are not what you see as shareholder. Don’t be seduced by them paying listing cost, you will be gauged with fees on the other side.

  6. Graeme December 14, 2017 at 5:15 PM #

    I keep an ongoing monthly record of the lowest asset figure I can find. Usually the ‘after everything’ NTA, unless I can find a lower one, then I use that. I then add back the dividends paid. Virtually all are franked at a rate similar to my marginal rate. Not perfect, but it’s simple and gives a pretty good idea of how well a particular LIC has performed for me over any period I like. This can be compared with other LICs. When I first started doing this, I was astounding at how much lower this performance can be compared with the ‘headline’ figure.

  7. John Derry December 14, 2017 at 6:14 PM #

    LIC monthly updates will never provide a complete picture. Not just prone to spin, they lag the market by days even weeks. The price movement is the truest and best performance indicator.

  8. Graeme December 14, 2017 at 9:13 PM #

    John; I suggest price movement is more the truest and best indicator of investor sentiment, rather than performance. Not the same thing, unless you’re a proponent of the efficient mark hypothesis, in which case there is no need to do compare different LICS because the market has already done it for you.

  9. Gen Y December 14, 2017 at 9:50 PM #

    etfwatch.com.au reports LIC performance by share price performance helping give an apples for apples comparison.

  10. Davis Gotz December 16, 2017 at 3:29 PM #

    Have always been bemused how some LIC report the amazing returns, yet the share is under the listing price, so anyone who bought originally was showing a loss, the only returns are capital growth and dividend, no more no less☺️

  11. John McEwan December 18, 2017 at 1:12 PM #

    Absolutely brilliant and insightful I have a reasonably substantial portfolio position in an LIC which quotes its performance as * prior to expenses and assuming all distributions are reinvested using the DRP. I feel this is a total misrepresentation. ??

  12. Steve December 18, 2017 at 2:09 PM #

    I agree entirely. I want to know how I am doing with the investment not how the manager is doing. Also, when reports are given about ‘performance’ what performance is it referring to? This is almost never footnoted. Is it total shareholder return? is it NTA per share? Is it EPS? It is just ‘performance’.

    Also, and the thing that bugs me the most is when we see “investment portfolio up 55% year to date’. This must sound great to anyone who doesn’t understand that that increase is mostly capital raising, DRPs SPPs or exercised options. This sort of things reminds me to be skeptical not to trust anything the manager tells me.

    The author has an influential voice, so I hope the LIC industry listens, because at some stage if the industry does not self regulate on these issues, one day the regulators will.

  13. Geoff Walker December 19, 2017 at 10:59 PM #

    This proposal makes perfect sense if managed fund performance reporting is what you regard as the paragonic exemplar of reporting. I don’t.

    Being an income-focused investor, what I’m most interested in reporting-wise is the income (dividends, interest, rent) generated by my portfolio and its rate of increase from the previous year, which I can then compare with benchmarks such as CPI and AWE. Next most interesting is the rate of increase in the market value (excluding income) of my portfolio over the year. Only third comes the total return à la managed funds.

    For my portfolio of directly-held shares these measures are easy to calculate. For my LIC investments, it takes a bit of effort using the annual report, but I can usually get there. For managed fund investments, where distributions confound dividends and realised gains, there’s no hope.

    Managed funds should look at improving their reporting of results to be of more use to investors like myself.

  14. Brent December 20, 2017 at 8:09 PM #

    Provided the data actually reported to them, Morningstar seems to have reasonable format for which to report LIC performance, particularly if looking for performance relative to traditional unit trust options.

    – LIC market performance (price + dividend)
    – Pre tax NTA
    – Post Tax NTA
    – Relevant market benchmark
    – Relevant peer category benchmark

    All reported on a 6mth, 1,3,5 & 10 year basis (along with some basic risk measures over the similar periods). You can also access more time granular charting data as well.

    It doesn’t quite capture the grossed up franking but neither does unit trust reporting so it looks to serve as a reasonable data point for investors or advisers with access to ARC or direct.

    I would eco the overall sentiment here however that if LIC’s are going to hold themselves out as direct competitors to unlisted trusts, then they need to be reporting like an investment trust and not like a small cap corporate.

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