Advantages and Tips in Investing in a Listed Investment Company

In order to make the most money possible, you must invest your money in the right places. That is why it is good to consider investing in a listed investment company. There are several advantages to doing this, and in this blog post, we will discuss some of them. We will also provide tips on picking the right listed investment company for you.

Are you looking for a more reliable and consistent way to invest your money? If so, a listed investment company (LIC) may be the right option for you. LICs are companies that offer shares to the public, which can be purchased just like any other share on the stock market.

But what makes LICs an attractive option for many investors is that they offer several advantages over unlisted investment companies and traditional stocks. In this post, we'll explore some of the key advantages of investing in a LIC and some tips for getting started.

If you're thinking of investing your money, you may wonder if a listed investment company is the right option. Listed investment companies, or LICs, are publicly traded on the stock market, which gives them a certain level of security and stability.

Do you want to invest but don't know how? Have you been investing for a while but feel like you could be doing better? This blog post is for you! In this post, we'll go over the basics of investing in a listed investment company (LIC) and provide some tips on how to get the most out of your investment.

Stay tuned – by the end of this post, you'll be a LIC investment expert!

What is a LIC?

Simply put, a listed investment company (or LIC for short) is an investment that has been organised as a business and then listed on the Australian Securities Exchange (ASX). Many LICs function in a manner that is analogous to that of a managed fund, in that they hire either an in-house or an external professional fund manager to choose and oversee the company's various investments.

Starting Point

We recommend that you begin your research by focusing on the Australian Foundation Investment Company (AFIC) and Argo Investments because they are respectively the country's oldest and largest LICs. Both have a number of desirable qualities and serve as a useful standard for evaluating and contrasting the qualities of other LICs.

To begin, they give customers access to a diverse portfolio that include the nation's most important stocks. Second, the teams responsible for managing the portfolios have a track record of success that is the envy of many other fund managers. In conclusion, the expense ratio of these funds is quite favourable when contrasted with that of other types of managed investments. Both Argo and AFIC are able to maintain some of the most competitive prices in the market.

The management expense ratio (MER), often known as the management expense ratio, is the metric that is most useful for comparing the costs of LICs and managed funds. The MER quantifies management and administration expenses as a proportion of the entire portfolio value.

For the 2009 fiscal year, both Argo and AFIC reported MERs of 0.19%, which indicates that investors paid just 19 cents for every $100 invested in order to have their money handled professionally for the year.

That's a significant discount compared to the expense ratios of most unlisted funds, which are often higher than 1.5% on average. It's also a significant discount compared to the expense ratios of a normal LIC. The changes in these costs can have a significant impact on your overall profits over the course of a long period of time.

How Does a LIC Function?

Closed-ended investment companies (LICs) do not issue new shares and do not cancel existing shares regardless of the number of investors who join or leave the company. Instead, they conduct an initial public offering in which they distribute a predetermined number of shares (IPO). The ability of investors to buy and sell these shares on the ASX frees the fund manager from having to worry about cash flow, which enables the fund manager to concentrate on investing.

1. Types of LICs

On the basis of the manner in which they make their investments, LICs can typically be placed into one of the following four primary types:

• LICs that are invested in stocks that are listed on the Australian Securities Exchange are called Australian Shares.
• LICs that invest largely in shares that are listed on abroad exchanges are known as investing in international shares.
• Private Equity Funds: These LICs are deemed to have a high level of risk because they engage in unlisted businesses both domestically and internationally.
• Specialist Funds: LICs that concentrate their attention on a particular industry sector, such as technology, energy, mining, real estate, or infrastructure; they may even invest in vineyards.

2. Listed investment companies (LICs)

A listed investment company (or LIC for short) is an investment that is traded on an exchange like the Australian Securities Exchange (ASX). It has been established as a corporation.

The management of many LICs is similar to that of managed funds. They have either an internal or an external fund manager who is responsible for choosing investments for the organisation and managing those investments.

LICs are considered to be "closed-ended." As investors join or leave the company, they do neither issue new shares nor do they cancel existing shares. Instead, they conduct an initial public offering in which they distribute a predetermined number of shares (IPO). After then, investors purchase and then dispose of those shares on the exchange.

This frees up a fund manager's mind to concentrate solely on investing rather than on keeping track of cash flow.

Since LICs are treated as corporations, they are permitted to make franked dividend payments.

3. Listed investment trusts (LITs)

A listed investment trust, or LIT, is an investment that is incorporated as a trust and is listed on an exchange such as the ASX.

In the same vein as closed-ended funds are LITs. Therefore, investors do business on the exchange by purchasing and selling units.

LITs are required to distribute 100% of their after-tax income to its investors in the form of trust distributions, regardless of the underlying investments. The degree of franking may be adjusted in accordance with the amount of income derived from the underlying assets.

Now that we've covered the basics, let's delve a little deeper into the "hows" and "whys" of investing in a LIC. The majority of potential investors are drawn to LICs because of the favourable tax treatment they provide. Because of the ongoing epidemic and historically low interest rates, investing in LICs can result in a reliable and tax-efficient source of dividend income, which is an extremely appealing proposition in today's unstable economy. This type of dividend income is referred to as "fully-franked" dividend income.

Make Sure That You Check Out The Underlying Investments

LICs and LITs that are several decades old often make their investments in either Australian or overseas share markets. The more recent funds have exposure to a wider variety of underlying assets, making them suitable for a wider variety of investors.

Categories of LICs and LITs

The following are the four primary classifications of LICs and LITs, based on the types of investments they make:

• Funds that invest primarily in listed Australian stocks are known as Australian share funds.
• Funds that invest primarily in stocks that are traded on international exchanges are known as international share funds.
• Investments made by private equity firms can be made in unlisted companies either domestically or internationally.
• Specialist funds are investments that are made in specialised assets or in certain industries, such as vineyards, technological businesses, infrastructure, or real estate.

1. Plans for Investing

Every fund takes a different approach to making investments, which can range from cautious to risky.

Although aggressive funds have the potential to produce bigger returns, they also carry a greater degree of risk. Short selling, leverage, and the usage of derivatives are examples of some of the riskier techniques that funds may employ.

Before you make an investment, you should first consider if the fund's structure, investing style, and underlying portfolio meet your requirements and goals.

2. Investment time frame

This kind of investment is appropriate for a time frame ranging from medium to long term (5 years or more). This is due to the possibility that the underlying assets will exhibit high levels of volatility.

The ins and outs of buying and selling LICs and LITs

On the ASX, you can purchase or dispose of LICs and LITs by working with a broker or opening an online trading account. Therefore, whether you buy or sell ordinary shares, you will be required to pay a booking fee.

1. Net tangible asset (NTA) backing

LICs and LITs will typically trade at a discount or premium relative to the value of their underlying net tangible asset (NTA).

The net tangible assets of a firm are the physical assets of the company, minus the company's liabilities. This indicates that the price at which a share trades may be more or lower than the value of the underlying assets for that share. Funds that have been around for a long time and have a track record of successful investment management typically trade at a premium. It is more likely for less established funds to trade at a discount.

2. Payments for management and performance

The following are examples of possible fees paid to the fund manager:

• a management fee (commonly 1-1.5% of net assets)
• a performance fee (commonly 15-20% of returns above a set benchmark)

No matter how well or poorly the fund performs, investors are still required to pay management fees.

There are some funds that do not levy a performance fee. On some accounts, the performance fee could still need to be paid even if the fund has a negative return. provided that the return is greater than the standard.

Benefits of LICs

1. Portfolio diversity

LICs are involved in a diverse range of assets. When you acquire a share in a LIC, you immediately obtain a portfolio that is diversified because the business typically owns numerous shares in a variety of different companies.

Compared to more conventional methods of investing, investing in LICs can provide you a better return on your money because you can get access to a more diverse portfolio with less of an upfront financial commitment.

For instance, you could buy into a LIC in a single transaction, which would result in you having shares in the property, international equities, mining, and technology all in one go. This diversification protects your investment from the turbulence of the market and raises the probability that you will be able to get stable and reliable income streams from your portfolio.

2. Structural advantage

LICs also have a structural advantage over managed funds, which might sometimes have the tendency to sell low and purchase high. This advantage allows LICs to sell low and buy high. How so?

When asset prices are low, which is when the majority of managers should be buying, investors often start pulling their money out of their investments out of fear that prices will continue to decline. This indicates that managers may be required to reduce the holdings of their fund in order to satisfy these redemptions. Therefore, they must sell at the same time as everybody else is selling.

When market conditions are favourable, money pours into funds, but there are fewer equities available that offer a good value for investors. The essence of these "flows," as they are referred to in the business world, is one that defies common sense. The realities of the industry tend to make it difficult for fund managers to purchase low and sell high, even if they had the intention of doing so.

LICs face no such problem. If an investor wants to get out of the game, they have to sell their shares to someone else in the game.

This may have an effect on the share price of the LIC, but it has no bearing on the underlying portfolio of the LIC. As a result, the manager is free to purchase and sell equities whenever they believe it to be suitable to do so. In contrast to a fund manager, they do not have their hands tied.

3. Cross-market exposure

Every single LIC category, with the exception of those that are only invested in Australian shares, has a respectable amount of exposure to markets in other countries. Some people also invest in a combination of stocks and bonds in order to make the most of the various investment vehicles that are accessible in the country.

4. Franked dividends

By avoiding double taxation, investors can increase the amount of money they get from franked dividends. This is because the money that is distributed to shareholders as dividends comes from profits that have already been taxed when they were taken out of the company's coffers.

Investors in self-managed superannuation funds (SMSF) who are interested in generating a stable and tax-efficient income have the option of utilising a trust structure to provide imputation credits and franking credits.

These can subsequently be passed on to shareholders, reducing their tax burden and, in many situations, even leading in a tax rebate from the ATO. This is possible since shareholders are considered to be tax-exempt entities. Even LICs with foreign interests can gain, albeit typically at lower levels, from franking credits.

On the other hand, an alternative investment option known as a unit trust structure is only eligible to receive franking credits from the companies in which it has invested and is required to distribute dividends on an annual basis.

The directors of a LIC have the discretionary ability to rebalance the dividend payments made by the firm, which enables the company to pay out a more predictable dividend stream that grows with the passage of time. Because of this, a LIC is able to provide a more reliable source of income in retirement.

5. A cost to be paid

After presenting a conceptual argument in favour of LICs, we ought to rein in our excitement a little bit. When purchasing any stock, the price at which you do it is of vital importance. LICs are no different. In addition, as long as you approach the issue of valuation in the correct manner, it is a very simple matter to solve.

Standard valuation yardsticks, such as the price to earnings ratio (PER), are of little value when attempting to assess LICs because they are simply collections of investments made in other companies. In point of fact, it is strongly recommended that the PER be completely ignored because it is highly likely to be extremely deceptive. Instead, the starting point for any valuation is the current market value of the LIC's assets, less any obligations it may have. This value is subtracted from any other liabilities the LIC may have.

It should therefore not come as a surprise that the price of a LIC has a tendency to reflect, at least roughly, the performance of its underlying portfolio over time. Consider the case of a listed investment company (LIC) that has a market capitalisation that is significantly larger than the market value of its portfolio. In that scenario, investors have the option to acquire each asset separately and then recreate the portfolio, which allows them to avoid paying management costs.

On the other hand, if the market capitalisation is smaller than the market value of the portfolio, then there is the possibility of getting something for nothing.

6. Managed fund

Because when you buy a share of a LIC, you are also buying a share of all the assets that it holds, you won't have to worry as much about the management of its many assets. These holdings are overseen by trained professionals who are tasked with making judgments that will generate a profit and increase the value of the portfolio as a whole.

7. Possible capital gains tax deductions

If the LIC in which you participate is more of a long-term investor than most others, the company may be able to provide you with additional tax benefits under certain conditions. For instance, if it sells investments for a capital profit, it might be required to pay a dividend that includes a Capital Gains Tax (CGT) component. [Citation needed] resulting in a capital gains tax discount for you as equivalent to what you would have received if you had directly held and traded shares in the underlying investee firm.

8. A steady source of income for retirement planning 

The strategic management approaches of LICs can, in addition to offering an investment opportunity in a stable fund base due to the close-ended nature of their capital structures, allowing you the flexibility to plan for your retirement and investments in the long term.

LICs that have long-term objectives make it possible for professional fund managers to impose lock-in periods and freezes on their revenue gains. This makes it possible for earnings to be reinvested after any taxes that are owed have been paid. This method assists in overcoming economic upheavals, which is especially helpful in the event of economic recession or inflation.

LICs also have the option to retain capital gains from shareholder distributions in order to reinvest the money for the purpose of increasing payouts. If the directors choose to implement this reinvestment method, it presents the possibility of expanding the retiree's overall benefits package and provides either a steady stream of income during retirement or a lump sum payment upon retirement.

9. Quick and inexpensive

Purchasing a LIC is much like purchasing any other stock on the share market; the process is really straightforward. Due to the fact that they are listed on the ASX, the trading procedure is uncomplicated and open to public scrutiny. In addition, in contrast to many other managed investments, investing in a LIC requires only a modest sum (usually beginning at $500), and the only expenses that are applicable are the brokerage fees.

10. Openness and responsibility

The transparency that comes with being subject to the regulations of the ASX and having a corporate structure that follows those regulations is another advantage that investors find attractive in relation to LICs.

The Australian Securities Governance Rules mandate that directors be held accountable and provide complete information to shareholders. In order to achieve this objective, a three-part threshold has been established, which LICs are required to meet. In addition to this, it guarantees dependability by adhering to rules such as:

• A shareholder has the ability to vote on any resolutions or special general settings that are brought up during an annual general meeting.
• The ASX Listing and Corporate Shareholder Transparency Rules require shareholders to communicate with one another and disclose all relevant information.
• Reporting on investments to shareholders on an annual, quarterly, and monthly basis, including information on net tangible assets and investment portfolios.

The existence of this barrier gives shareholders a crystal clear picture of how their money is being spent and how their assets are faring as a result of the investment.

Some Things to Think About

When purchasing LIC shares, you should ensure that you have done your research on what the firm has to offer before making a purchase. Before you entrust your finances to a LIC, there are a few things you should take into consideration, which are outlined in the following list. If you are unsure what to search for in a LIC, read it.

1. Understand the investment approach

What criteria does the company use to determine which stocks to acquire and which to dispose of, and how does it apply those criteria? Do they permit short selling on their portfolios of investments? How about we talk about gearing? Know exactly what you're getting yourself into before investing in a LIC stock.

What about their participation in the various markets? It's possible that the LIC is putting their money into a foreign market that isn't performing so hot right now.

Make sure you are familiar with the underlying assets that the LIC invests in. Is their investment focus on real estate, financial options, bonds, or stocks? If they are active in a certain industry, you should evaluate the state of the organisation as a whole to determine how they stand. Determine whether the stocks there are overvalued or undervalued and report your findings.

2. Manager performance

Examine the asset manager's track record to see how well they have performed in the past when managing funds. The success of the portfolio should then be evaluated based on its annual returns after all costs and fees associated with management, with the exception of taxes, have been deducted. Compare this with the average performance of their competitors' portfolios.

You shouldn't just look at the results of the most recent year; instead, you should consider longer timeframes. Be sceptical of managers who have shown outstanding performance in the short term. It's possible that they've just been having one of those years where everything is going up.

The means by which each fund seeks to maximise its returns on investment might range from a risky strategy to a more cautious one. Because of the growth tactics that are utilised, aggressive investment plans typically result in better returns; however, they also carry a greater level of risk.

3. Liquidity of shares

The ASX is home to a large number of LICs, which means that not all of them move at the same pace. In addition, some of them can have liquidity problems, which would prevent you from readily buying and selling stocks in those companies.

4. Fees

The fees that are imposed by LICs are often greater when compared to those that are charged by ETFs and other managed products. Clients of fund managers are typically charged a management fee in addition to a performance fee. Make sure that the fees won't just eat up your predicted profits because certain fees, particularly the management fee, are imposed regardless of how well the fund performs.

5. LICs trading at a premium/discount

LICs that have a successful track record typically trade at a premium compared to both the value of their competitors and the value of their Net Tangible Assets (NTA). Those organisations, such as the Australian Foundation Investment Co., etc. Due to the fact that Ltd. and Argo Investments have an established reputation in the industry, their prices are higher.

They have seen both bearish and bullish cycles as well as market crashes in the past. The fact that they are still in business despite their poor fund management demonstrates how durable and effective they are.

On the other hand, newer LICs sell at a discount due to the fact that they have not yet demonstrated that they are adept at financial management. However, you shouldn't assume that they are a good value simply because they are more affordable. It's possible that you'll feel as though you're receiving a great deal because the company you're purchasing has a market value that's quite low. Be careful to perform adequate research before purchasing them because there is a rationale behind the price at which they are sold.

Your decision to select a LIC will be impacted by these many considerations. Pick a LIC that is always in line with your profit goals and the amount of risk you are willing to take.

Two NTA Figures

Therefore, a LIC's market price should be relatively similar to the value of the company's net tangible assets (NTA), minus a small amount to take into account recurring payments (or a lot of those fees are excessive). However, if you go through the yearly reports of a LIC, you'll notice that there are at least two different NTA values.

The first one is called "pre-tax NTA," and it refers to the value of a company's assets minus its liabilities, expressed as a value per share. If a LIC makes a profit off of its assets, then the sale of those interests will result in the payment of capital gains tax. When calculating post-tax NTA, the amount of tax that would have to be paid in that scenario is subtracted from the total.

LICs that are more concerned with the long term, such as AFIC and Argo, claim that they ought to have a valuation that is closer to the NTA before taxes. This is due to the fact that they only sometimes sell the shares they own, which causes them to delay making their tax payments. Therefore, their shareholders are, in fact, receiving a loan from the tax office that does not accrue any interest, and that money is earning dividends for them.

However, in the event of a liquidation, such an argument would not hold any water. If you have a profit, it is expected that you will pay tax on it at some point. Due to the fact that Argo and AFIC typically have deferred tax liabilities that are equivalent to 10 to 15% of NTA, we would not recommend paying a premium that is more than a few percent higher than post-tax NTA. That ought to offer a certain degree of margin for error.

Conclusion

Investors who are seeking a way to buy shares of foreign markets, get engaged in specific industries exclusively, or get a hold of a combination of diverse investment assets will find that LICs are intriguing investment vehicles.

You shouldn't, however, buy any LIC you come across just because it's inexpensive or seems to be undervalued. This is not a good strategy. The same is true for highly priced LICs, where the costs you pay could end up being higher than the earnings returns you receive.

As long as you do your homework before investing, purchasing stock shares in a LIC might turn out to be a smart move for you. Always consider the performance of the LIC over the long term, the kind of assets it holds, the management approach used by the LIC, and the price of the LIC relative to the NTA to determine whether or not it is trading at a fair value.

As you can see, investing in a LIC can provide you with a number of benefits, but only if you put in the necessary preparation and are willing to adhere to an investment strategy that is designed to provide maximum returns over the long term. There are a lot of different approaches to planning your financial investments, but the first thing you need to do is find a good financial counsellor to work with.