Potential to access a consistent, growing stream of fully franked dividends through listed investment companies.
Driven in part by a surge in popularity among self-managed superannuation funds (SMSFs), the listed investment company (LIC) sector has experienced considerable growth in recent years.
For SMSF investors seeking to diversify their investment portfolio, LICs offer several advantages, including a consistent and growing stream of fully franked dividends and the ability to outperform managed funds.
Importantly, because LICs use a corporate structure their boards and investment managers must act in the best interests of all shareholders and report at least annually to all shareholders.
For most SMSF investors, the main benefit of a LIC is its ability to pay a consistent and growing stream of fully franked dividends. Unlike managed funds, which use a trust structure, LICs derive franking credits from tax paid on realised company profits, in addition to the imputation credits from underlying investee company dividends received. Realised profits can be paid to shareholders over time.
A managed fund also flows through to unitholders any dividends received from investee companies but must pay out all the realised profits in the financial year they are received. Therefore, managed fund distributions fluctuate depending on market conditions.
In contrast, a LIC can retain dividends and other capital profits in a profit reserve. A LIC can use this retained profit to pay a consistent and growing stream of fully franked dividends over time and through market cycles.
Depending on where shares are held and the applicable tax rate, over time LIC shareholders can significantly enhance their after-tax income using these franking credits. For SMSFs, the imputation credits can be used to reduce the SMSF’s tax liability or, in most cases, are refunded by the ATO.
Outperformance of managed funds
As LICs are a close-ended pool of capital they do not have to manage capital inflows and outflows from applications and redemptions. This allows the investment manager to make rational, long-term investment decisions based on sound principles.
Compared with managed funds, which manage an open-ended pool of capital, a LIC manager is not compelled to sell assets (often at the bottom of the market) to fund redemptions. Similarly, they are not forced to buy shares due to fund inflows, which often occur at the top of the market.
Research shows that a LIC’s close-ended, permanent capital structure enables it to invest more efficiently and outperform unit trusts and other managed funds over time.
Accountability to shareholders
A LIC’s listed company structure ensures accountability of the board and investment manager. LICs are required to comply with the Corporations Act and various governance principles, and the board must act in the best interests of all shareholders.
Various statutory obligations give shareholders the opportunity to communicate and engage with the board and management, including through annual general meetings.
Each month, a LIC publishes its net tangible assets (NTA), top holdings and often additional information, providing investors with additional transparency.
With a minimal investment and for the cost of brokerage, SMSF investors can utilise LICs as a simple and effective way to create a diversified investment portfolio, or complement existing directly held investments.
There are 80-plus ASX-listed LICs, which broadly fall into four categories:
1. Australian equities LICs
Most ASX-listed LICs invest in a portfolio of Australian equities, often concentrating on a segment of the market, such as large-cap, small to mid-cap, micro-cap or nano-cap companies. Although the ASX Top 20 accounts for more than 60 per cent of the market’s value, there are more than 2,200 listed companies.
LICs focused on smaller companies can offer broad market diversification for SMSF investors lacking the time, resources or expertise to invest outside the Top 20.
2. International LICs
SMSF investors can gain access to global markets through those ASX-listed LICs with international mandates, either currency hedged or unhedged. These LICs are particularly appealing relative to their managed fund peers, as they have the capacity to pay franked dividends over time.
3. Impact LICs
Future Generation Investment Company (ASX: FGX) and Future Generation Global Investment Company (ASX: FGG) each offer their investors access to a group of fund managers through a single LIC, while also supporting Australian charities working to better the lives of young Australians.
The fund managers of the Future Generation vehicles act on a pro bono basis (zero per cent management fees and zero per cent performance fees), allowing these LICs to donate 1 per cent of their net tangible assets each year. These impact LICs offer unprecedented access to a group of Australian equity and global fund managers.
4. Specialist LICs
Particularly in more recent times, many specialist LICs have been established offering exposure to specific sectors (such as technology and mining), different investment strategies (including buy-write and activist strategies) and alternative asset classes (including private equity and hedge funds). These LICs provide SMSFs with further opportunities for diversification across asset classes, investment styles and industries.
Considerations before investing in LICs
There are several important factors to consider in assessing a LIC as an investment proposition. Of paramount importance is the LIC’s track record of performance, as it reflects the quality of the investment manager and the success of their investment strategy.
It is also critical to consider the quality of the board and the company’s approach to capital management, ensuring it has a clear dividend strategy. LIC company investor websites, reports by independent research houses and the ASX website provide useful information to understand and assess LICs.
Depending on the investment objectives and strategy, LICs can provide SMSFs with exposure to companies of various size, asset classes, investment styles and managers, industry sectors and geographic regions, as well as making a positive social impact, while leveraging the advantages of the LIC structure.