What is a listed investment company (LIC)?

What is a listed investment company (LIC)?

A listed investment company, or LIC, is a particular type of active investment fund. LICs are registered like public companies, and shares in LICs can be bought and sold over an exchange like the ASX.

That's a lot to unpack, so let's start with the 'active' part.

As actively managed funds, LICs have a professional manager who decides which assets the fund should buy and sell on behalf of investors and in what proportions.

The management company will charge a fee to do this, called the Management Expense Ratio, or MER. It’s the annual fee as a percentage of the company's net tangible assets (NTA). Some LICs also charge a performance fee if the management company achieves higher returns than a particular benchmark it measures itself against.

What makes LICs unique is they are 'closed-ended'. This means there are restrictions on how many new shares they can create or cancel, so LICs can't just issue more shares if there is a surge in demand from investors. This has benefits and drawbacks, which we will discuss below.

What are some examples of a LIC?

There are about 100 LICs listed on the ASX, most of which focus on investing in Australian and international shares.

The largest listed LIC by market capitalisation is the Australian Foundation Investment Co. Ltd (ASX: AFI). The company compares its performance to the S&P/ASX 200 Accumulation Index (ASX: AXJO) and is popular for its diversified portfolio of some of Australia's top listed companies.

Argo Investments Limited (ASX: ARG) is the second-largest LIC in Australia and undoubtedly one of the oldest. The company was established in 1946 and has investments in about 100 different Australian equities, with a particular focus on providing a sustainable dividend.

The Forager Australian Shares Fund (ASX: FOR) specialises in finding and investing in smaller ‘'deep value’ stocks that bigger investors might miss.

Benefits of investing in LICs

The beauty of the closed-ended LIC structure is that the company doesn't redeem or create units, so it isn’t forced to sell its investments if a shareholder wants to cash out. Instead, investors sell to other investors on the share market. 

This creates stability for the fund manager and leaves them free to make long term investment decisions and take advantage of the ups and downs of the market.

LICs can also provide exposure to a large number of companies, thereby making it quick and easy to diversify your investments through a single trade. 

Compared to mutual funds, shares in LICs can be more convenient to buy or sell because they are listed on the share market, just like individual companies. Having a professional manager at the helm of a LIC is also very appealing to some people.

Drawbacks of investing in LICs

One drawback of actively managed LICs is they often have higher fees than exchange-traded funds (ETFs), especially low-cost passive ETFs that simply mirror the returns of an index.

A potentially more significant drawback of investing in LICs is the risk of not being able to sell when you need to at an acceptable price. 

With a managed fund, when you want to buy or sell, the units are purchased or redeemed directly with the fund. However, as shares in LICs are bought and sold on the share market between investors, they can be hard to sell if no one is buying at the price an investor wants. 

This can create a disconnect between the share price and the value of the LIC's net tangible assets. It can also be a big problem if you need your money in a hurry or if the LIC becomes unpopular with investors. Conversely, if the LIC is especially popular, shares might trade at a premium price above the value of the assets.

Finally, LICs generally only report the value of the assets they hold at infrequent intervals, making it hard to know the value of assets at a given point in time. 

On the other hand, ETFs report the value of their positions daily.

Alternatives to investing in LICs

While there are some obvious advantages to investing in LICs, the drawbacks mean they’re not for everyone. Two alternatives to investing in LICs are managed funds and ETFs, which could be considered close cousins.

Managed funds can look very similar to LICs in that a managed fund is a pool of investors’ money that gets put to work by a fund manager. Unlike LICs however, managed funds exist outside the ASX. Managed funds are usually 'open-ended', which means that units in the fund can be created and redeemed directly with the fund manager.

ETFs can be active or passive investment funds that are bought and sold over an exchange like the ASX. ETFs are 'open-ended' and are designed so that the price per unit trades very closely to the fund's net tangible assets.

If the value of the ETF units falls below the value of the underlying net tangible assets, a special company called an 'authorised participant' can swoop in and buy units in the ETF, which pushes the price back up. 

An authorised participant is an organisation such as a large bank that has the right to create and redeem shares. The units then get exchanged for the underlying assets, which can be sold for a profit —a form of arbitrage.

Passive ETFs track the returns of a particular index, like the S&P/ASX 200 Index (ASX: XJO), by holding shares in the same proportion as the index. They don’t require a manager to make buying and selling decisions, so they charge much lower fees than some LICs, making them an efficient way to invest your money.

 

Updated 21 April 2022. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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