New research by Stockspot chief executive Chris Brycki and his associate Marc Jocum finds that nearly all Australian equity LICs have underperformed the local share market index exchange traded fund (ETF) over the five years to June 30.
“Ninety-five per cent of Australian share LICs failed to beat the Australian share index ETF over five years,” says Brycki, a former UBS portfolio manager.
“Two-thirds of all [equity] LICs available on the ASX had a negative return over the year despite Australian shares rising 11.6 per cent and global shares rising 12 per cent.”
Underperformance was similarly evident for LICs and LITs specialising in global equities compared to world ETF indexes.
Brycki operates an online robo-advice firm and advocates for clients to use low-fee passive index funds.
He says LICs used to be one of the best ways for an investor to gain access to a diverse portfolio of shares in one transaction through long-standing vehicles such as the Australian Foundation Investment Company and Argo Investments, which have very low management fees.
But the rise of low-cost index funds and flood of dozens of new poor-performing LICs means the investment rationale for listed funds is now much harder to justify.
‘Government needs to urgently ban commissions’
Brycki says despite the “disastrous performance”, the LIC market continues to enjoy phenomenal growth.
“LICs are another excellent example of a loophole in the Aussie investment advice industry that puts the financial remuneration of the people selling investments over the financial wellbeing and best interest of their clients.
“The government needs to urgently act to ban commissions on all new LIC issuances so Australian consumers start to get better advice from their advisers and stockbrokers.”
Brokers and some advisers can earn commissions of 2 per cent to 3 per cent to sell new LICs, which have become more exotic beyond traditional listed shares to include hedge funds, private equity, direct loans and leveraged junk bonds.
To be sure, equity LICs can deliver slightly higher fully franked dividends to investors than ETFs, a factor not fully reflected in the price of LICs.
But the Vanguard Australian Shares Index ETF still pays an 80 per cent franked dividend.
Investors should be careful how some LICs publish their returns.
Sometimes fees are excluded.
Many listed fund managers publish their performance based on the value of the assets inside the LIC (the net asset value), not the ASX market price of the LIC that investors can buy and sell at.
More than half of LICs were trading at a discount of greater than 10 per cent of their pre-tax net tangible asset value as of June 30, according to an AFR Weekend analysis of Morningstar data.
Wilson Asset Management founder Geoff Wilson, who manages six LICs worth $3 billion, says when LICs trade at sustained discount the board should do a share buyback or pay back capital to investors.
“Discounts and premiums change over time and the disconnect provides the buying or selling opportunity for investors,” Wilson says.
Poor performing and sub-scale LICs trading at large discounts to NAV, such as Watermark and Monash Absolute Investment Company, were wound up by their directors or converted into a new vehicle to help shareholders.
Another option is to remove the fund manager, something easier said than done.
Hong Kong-based private investor Tim Staermose says it’s “far too hard, even for professional activists to remove and replace underperforming managers” under the Corporations Act.
Staermose fought a tough activist battle to wrestle control of the ASX-listed Aurora Absolute Return Fund after it suffered a near-80 per cent decline in value.