I think one of the best reasons why shares are such a great investment is listed investment companies (LICs).
I have already written that returns, dividends and exchange-traded funds (ETFs) are three of the best reasons to invest in shares.
The ability to invest in a LIC is one of my favourite thing about shares, with compound interest and dividends being the other two great factors to me.
What is a LIC?
As the name might suggest, it's a company that invests in shares of other businesses. So instead of running a supermarket business like Woolworths Group Ltd (ASX: WOW) or a bank like Commonwealth Bank of Australia (ASX: CBA), the management of the LIC invests in other shares for you.
There are some LICs that largely invest in large blue chip ASX shares. There are some LICs that invest in small cap ASX shares. There are some LICs that invest in overseas-listed shares.
Why choose a LIC over an ETF?
ETFs are a great way to invest to achieve the average market return whilst providing diversification. However, there are four reasons why I like choosing LICs:
Dividends
ETFs just passively achieve capital growth and pass through the dividends that the underlying companies pay – which is totally fine, but the income payments can be inconsistent. However, LICs have the ability to smooth out their dividend payments because LICs can pay dividends from the capital returns they produce and the dividends they receive from the investments.
You'd have to sell some of your ETF investment to access the underlying capital increase.
Having control of the dividend means that payments to shareholders can steadily grow – giving income certainty – as long as the LIC has enough profits in reserve.
Discount to net assets
If you go to your share broker and want to buy shares of CBA, you have to pay the current selling price. If you want to buy units of an ETF you always have to pay $1 of cash for $1 of shares.
LICs can trade at a discount to their actual net assets. For example, a LIC may own $1 of assets per share, but its share price is only $0.85. That means you're getting those shares in the LIC at a 15% discount to the actual value if you were to go and buy those underlying shares yourself.
Sometimes it's justified that LICs trade at a discount if their investment returns are poor, but you can occasionally find good LICs that trade at discounts.
Of course, LICs can also trade at a premium to their net assets.
Investment flexibility
ETFs are stuck owning whatever shares their benchmark requires. If BHP Group Ltd (ASX: BHP) is at an all-time high because of cyclical factors, the ETF has to stay invested when it could make sense to sell. Similarly, if BHP was at a low point like in 2016, the ETF has to keep it at a lower allocation even if it would make sense to buy more.
LIC investment managers can decide when to buy and when to sell. The global share LICs have enormous flexibility to invest anywhere in the world.
Can outperform
It's statistically true that many fund managers underperform the average market return, particularly after fees. But there are a group that can outperform over the long-term. Sometimes those good ones will have a poor quarter or a poor year, but that could be the best time to buy them because performance often reverts back the next year.
What LICs could be good options?
It depends what you're looking for. There are some set up for high capital growth but low income, others have high dividend yields but won't generate much share price growth because they pay out most of their profit each year as dividends.
MFF Capital Investments Ltd (ASX: MFF) is a global share LIC and it has consistently been a top performer since the GFC with a focus on structural growth shares like Visa and MasterCard. MFF Capital has low fees but it also has a low dividend yield.
Magellan Global Trust (ASX: MGG) is a listed investment trust (LIT) with a focus on global shares, the investment strategy used by its manager has created excellent long-term returns and it has a reputation for good 'downside' protection risk too, in other words it nearly always goes down less when the market declines. Magellan Global has high fees, but its net performance is strong and it targets a 4% distribution yield.
WAM Microcap Limited (ASX: WMI) is an ASX small cap LIC, targeting shares worth under $300 million. Since inception a couple of years ago it has performed extremely well. When the share market drops small caps tend to fall more, but in normal times small caps can outperform. Over the next five to ten years, WAM Microcap could be the best LIC performer. It has a grossed-up ordinary dividend yield of 4.3%.
WAM Global Limited (ASX: WGB) is focused on global shares. It has useful investment flexibility and Wilson Asset Management have a preference for steady dividend growth, so this could turn into a very good dividend share over time. It has only just started paying a dividend, so the yield is quite low.
Australian Foundation Investment Co.Ltd. (ASX: AFI) is focused on large ASX shares. It would be silly of me not to mention the biggest LIC on the ASX. It has shown very good dividend reliability over the past 20 years – every year has seen the dividend maintained or increased. However, I'm not a huge fan because I don't think many of its largest investments (like the banks) are going to do well over the coming years.
Washington H. Soul Pattinson and Co. Ltd (ASX: SOL) is not really a LIC, but it acts like one. It invests in other businesses, it has been going for over a century, it has paid a dividend every year of its existence and it has increased its dividend each year since 2000. It has a grossed-up dividend yield of around 4% today.
There are other LICs with much higher dividend yields, but they come with fairly high fees so it would only make sense to go for them unless income is your only concern.
Foolish takeaway
Each of the above investments are solid ideas in their own right, which is why all of them (except AFIC) are in my portfolio. Geoff Wilson has been buying WAM Global shares this month, so it's probably still good value. I think WAM Microcap and MFF Capital will likely keep going well over the long-term. Soul Pattinson and Magellan Global are two great investments with a focus on the long-term – they are my preferred two. Just like ETFs, it's feasible that you can pick a LIC and hold it for the rest of your life.