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The continued expansion of Listed Investment Entities (LICs/LITs) as an option for investors continues to cement their visibility as an alternative to unlisted managed funds. While the velocity of capital flowing into the sector has been impressive under fertile market conditions, investors should not overestimate the ability of the sector to cope with the next inevitable market downturn. Many of the investment managers that have come to the listed market in recent years have yet to experience operating a listed product during a full-blown market crisis.
Unlike unlisted managed funds, LICs/LITs face an additional challenge – the vagaries of navigating an equity market listing. One of the key challenges has been the ability of a listed vehicle to trade at a discount to its underlying asset values. This issue can prove vexing at the best of times, however, during market turmoil, it can become a serious issue for a board and/or investment manager should discounts become deep and persistent.
Given management often have a relatively limited array of tools to rectify discounts in a meaningful way, it stands to reason that those who construct and operate LICs/LITs should make use of all available tools to maximise market integrity and client confidence in their products.
We’ve compiled a list of the top ten issues that should constitute a contemporary, best practice approach in launching and operating listed investment entities. While most of these views relate specifically to LICs, some are also applicable to LITs. Also, for LICs there are some differences between internally managed vehicles (investment management employed by the LIC) and externally managed vehicles (investment management outsourced under a management agreement).
1. Daily disclosure of net assets per share/unit
In liquid markets, the ability to value a portfolio of securities on a daily basis is typically a straightforward matter. While acknowledging that in a free market, investors can bid and offer as they like for listed securities, more transparent valuation of these assets on at least a daily basis puts listed vehicles on par with most managed funds.
2. Transparent performance reporting
Performance reporting for LICs can be a complex topic, as there are multiple methods available.
For LICs:
For LITs:
While each of these has different implications, for each structure, all measures should be made available to enable investors to get a transparent view of the different aspects of performance across the market.
3. Quoting portfolio investment performance after fees
While accepting that viewing a manager’s performance before fees is the purest way of measuring expertise, it is essentially irrelevant given managers don’t operate at zero cost. For externally managed LICs/LITs, only quoting investment portfolio performance before fees is fundamentally misleading.
4. A clear statement of quantitative performance objectives
Most unlisted managed funds state a defined performance objective (benchmark relative or an absolute performance figure) either on a pre or post fee measure. The majority of LICs however, simply maintain a high-level company objective such as growing dividends and/or achieving capital growth. While acknowledging that many LICs see stability and growth in dividends as a highly desirable characteristic for shareholders, failing to supply a more quantitative objective for portfolio returns is not a contemporary aspect of modern investment management. Providing clearer investment objectives provides investors with greater transparency with regards to returns expectations and the level of risk embedded in a LIC’s portfolio.
5. Quoting performance before franking credits
While we accept that franking is an important part of shareholder returns for LICs, with some managers quoting returns including franking and others not, this creates difficulties for those seeking to accurately compare company performance. Best practice is to adopt the methodology used by most managed funds and exclude franking credits. If LICs wish to provide performance inclusive of franking, this can be easily done using a separate data series.
6. Quoting fees inclusive of GST
Notwithstanding the implications of taxation law regarding GST requirements, it should be recognised that trusts and companies typically treat GST differently. The majority of LICs quote management fees exclusive of GST while LITs (and unlisted funds in a trust structure), typically quote fees inclusive of GST. While investment managers may be able to utilise reduced input tax credits (RITC) to reduce the effective GST level, inconsistent reporting of the impact of GST on fees creates an inequitable playing field for fee comparison across fund structures. All fees should be quoted inclusive of GST, net of RITC where applicable.
7. Detailed monthly performance updates
It has long been an accepted practice that fund managers provide at least some level of information as to the monthly positioning of the portfolio. A simple statement of the vehicle’s net assets per share/unit for the month adds little value in providing transparency on how a fund is positioned, or the views of management.
8. Defraying capital raising costs
The concept of covering the listing costs of an IPO so that the initial asset backing matches the listing price of a LIC or LIT is relatively new to the industry. While this is positive, there are multiple approaches and some are superior to others. The most common methods, ranked by attractiveness, is as follows:
While the trend to cover listing costs is an overall positive development, it is worth noting that managers of unlisted funds must also bear the cost of launching a fund, which is typically amortised in the fund accounts over time. Also, it should be noted that in examining the issue of funding IPO costs, this does not translate into our broad support for broker and/or adviser fee models for listed instruments, which is a broader industry question.
9. Removing termination fees from Investment Management Agreement (IMAs)
The presence of termination fees within IMAs for externally managed vehicles has the potential to be strongly detrimental to investor interests. While termination fee provisions (commonly referred to as ‘poison pills’) can potentially act as a deterrent to hostile management takeovers for companies, their presence is detrimental to investors seeking to remove poor quality investment managers.
10. Remuneration of executive board directors
It is best practice for executive directors of LICs to receive zero remuneration for a board role. Whilst board duties do take up time and resources for the individuals involved, it should also be recognised that executive directors are indirectly remunerated via management fees earned under the IMA. If you view a LIC as ultimately another channel for raising capital (similar to multiple unit classes in unlisted funds), executive directors are arguably being remunerated twice.
Many of the items listed here are long-standing features of LICs/LITs. However, we believe that quality managers should not hesitate to challenge the status quo and remove or otherwise limit negative features to the best of their ability. The recent and aspiring entrants to the LIC/LIT market must ensure that they seek to remove or otherwise limit all potential obstacles to negative investor sentiment regarding the structural and support aspects of a vehicle.
By Dugald Higgins, Head of Property & Listed Strategies.
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