Mathias Cormann looses dodgy security tsunami in LICs and LITs

An income-dependent Boomer mate recently asked me what I thought of Listed Investment Companies and Listed Investment Trusts (LIC and LITs). He’s being pushed to invest in them by a financial planner because his term deposit income has fallen.

I didn’t know enough about it be useful so set about investigating for him. What I found is disturbing.

LICs and LITs are listed investment entities that are usually close-ended which makes them illiquid and difficult to sell. They generally buy other securities – either debt or equity – and are actively managed by a team.

This is not a great investment structure for “mums and dads” for starters, creating an opaque structure that is not easy to exit from, so that got me piqued about why my mate was being sold these things in the first place.

That’s where it started to turn from worrying to alarming.

It turns out that LITs and LICs are something of a post-FOFA special breed of security. Those among you that recall the 2012 FOFA laws will know that it was legislation designed, fundamentally, to remove the conflicts of interest inherent in financial advisors selling products on commission.

But in 2014, the Coalition spearheaded by Mathias Cormann opened a loophole in the legislation that allowed LICs and LITs to exclusively pay financial advisor commissions. Via the AFR earlier this year:

The federal Labor Opposition has slammed a loophole created by the Coalition government that allows financial advisers to sell listed fund investments to clients and be paid lucrative commissions in return.

Labor shadow minister for financial services Stephen Jones has deep concerns about conflicted remuneration for selling LICs. Lisa Maree Williams

Shadow financial services minister Stephen Jones hit out at the “conflicted remuneration” after AFR Weekend revealed some independent advisers blew the whistle on peers for aggressively pushing listed investment funds, such as listed investment companies (LICs) and listed investment trusts (LITs).

The share price collapses of Dixon Advisory’s US property fund and Melbourne hedge fund L1 Capital’s LIC, both listed on the Australian Securities Exchange, have triggered calls for regulators to crack down on advisers and brokers selling listed funds.

The rest is history, also at the AFR:

The LIC market has rapidly doubled to $45 billion since 2014, when the Coalition government watered down Labor’s Future of Financial Advice (FOFA) laws to allow advisers and brokers to resume receiving commissions for selling listed securities.

FOFA was intended to end conflicted remuneration for financial advisers, but some advisers are receiving commissions of up to 3 per cent to sell LICs and listed investment trusts (LITs) to mum and dad investors.

3%!!! No wonder my Boomer buddy is having these things jammed down his throat.

I went further and looked up how the securities are trading. Here’s the wrap from the ASX:

LIC Statistics 09-Dec-19
ASX LICs ASX Fixed Income LICs
No. of Funds 111 100.0% No. of Funds 10 100.0%
Trading at Discount 88 79.3% Trading at Discount 1 10.0%
Trading at Premium 19 17.1% Trading at Premium 8 80.0%
Trading at Par 1 0.9% Trading at Par 0 0.0%
Not Trading (nil data) 3 2.7% Not Trading (nil data) 1 10.0 %
Avg. Discount -12.8% Avg. Discount -4.9%
Avg. Premium 9.3% Avg. Premium 2.4%
Mkt Cap Wtg Discount -6.3% Mkt Cap Wtg Discount -4.9%
Mkt Cap Wtg Premium 3.2% Mkt Cap Wtg Premium 1.9%
1Y Total Return – Avg. 8.5% 1Y Total Return – Avg. 0.7%
1Y Total Return – Median 9.5% 1Y Total Return – Median 7.4%

 

BBG Ticker
Long_COMP_NAME
PX_LAST FUND_NET_ASSET_VAL FUND_NAV_DT FUND_PCT_PREMIUM
OEQ AU Equity Orion Equities Ltd/fund 0.09 0.12 31/10/2019 -43.6%
SVS AU Equity Sunvest Corp Ltd/Fund 0.23 0.37 31/10/2019 -39.2%
ABW AU Equity Aurora Absolute Return Fund Suspended 0.30 29/08/2019 -35.0%
AUP AU Equity Aurora Property Buy-Write Income Trust 2.51 3.79 27/09/2019 -33.8%
8EC AU Equity 8IP Emerging Cos Ltd 0.07 0.10 31/10/2019 -29.4%
ECP AU Equity ECP Emerging Growth Ltd 1.10 1.32 31/10/2019 -27.3%
LRT AU Equity Lowell Resources Fund 4.50 5.91 27/11/2019 -26.2%
GFL AU Equity Global Masters Fund Ltd/Fund 1.95 2.51 31/10/2019 -25.1%
BEL AU Equity Bentley Capital Ltd 0.03 0.07 31/10/2019 -23.8%
NGE AU Equity NGE Capital Ltd 0.64 0.79 31/10/2019 -23.6%
BAF AU Equity Blue Sky Alternatives Access Fund Ltd 0.86 1.12 31/10/2019 -23.4%
TOP AU Equity Thorney Opportunities Ltd/Fund 0.68 0.86 31/10/2019 -22.1%
KAT AU Equity Katana Capital Ltd/Fund 0.81 0.98 31/10/2019 -21.2%
OZG AU Equity Ozgrowth Ltd/Fund 0.17 0.21 26/11/2019 -20.7%
NAC AU Equity NAOS Ex-50 Opportunities Co Lt 0.94 1.17 31/10/2019 -20.5%
ALF AU Equity Australian Leaders Fund Ltd 1.00 1.19 31/10/2019 -20.2%
CD3 AU Equity Cordish Dixon Private Equity Fund III 1.40 1.85 31/10/2019 -17.8%
CD1 AU Equity Cordish Dixon Private Equity Fund I 1.55 1.96 31/10/2019 -17.5%
FPC AU Equity Fat Prophets Global Contrarian Fund Ltd 0.98 1.17 20/11/2019 -17.4%
TEK AU Equity Thorney Technologies Ltd 0.28 0.33 31/10/2019 -17.4%
SEC AU Equity Spheria Emerging Co Ltd 1.78 2.10 22/11/2019 -16.8%
MEC AU Equity Morphic Ethical Equities Fund Ltd 1.00 1.17 21/11/2019 -16.8%
CDM AU Equity Cadence Capital Ltd 0.74 0.88 22/11/2019 -16.5%
FPP AU Equity Fat Prophets Global Property Fund 0.94 1.19 31/10/2019 -16.4%
NSC AU Equity Naos Small Cap Opportunities Company Ltd 0.74 0.89 31/10/2019 -16.3%
ACQ AU Equity Acorn Capital Investment Fund Ltd 1.24 1.40 31/10/2019 -16.2%
BTI AU Equity Bailador Technology Investments Ltd 1.02 1.18 31/10/2019 -16.1%
LSX AU Equity Lion Selection Group Ltd/Funds 0.51 0.47 31/10/2019 -16.0%
D2O AU Equity Duxton Water Ltd/LIC 1.36 1.72 31/10/2019 -15.7%
PGF AU Equity PM Capital Global Opportunities Fund Ltd 1.21 1.42 22/11/2019 -15.6%
MA1 AU Equity Monash Absolute Investment Co Ltd 0.98 1.14

80% of them are trading at discount to net tangible assets (NTA). This is owing to a toxic brew of poor management, having to pay staggering fees to financial planners, and the closed-end structure which means that if something happens to the manager then NTA takes a back seat to the problems in the fund because it is so hard for investors to exit.

And that’s in the good times. Looking back at the history of similar structures shows that once volatility rises, LICs and LITs can crash to zero in a jiffy given, yes, they also use leverage. Think Storm Financial, Allco and Adelaide Managed Funds.

I sniffed around some market sources and discovered, you’ll be shocked to know, that there is a tsunami of these things queued up to come to market. No doubt there is an equally large pool of financial advisors ready to suck up their 3% cut to sell them onto naive mums and dads.

That was enough. I rang my Boomer buddy and briefed him on the above while suggesting, subtley, that he find a new and less conflicted financial advisor.

When these things do come-a-cropper for real, and they will, the nation should personally bill the magnificent Matthias Corman.


David Llewellyn-Smith is Chief Strategist at the MB fund and MB Super which uses separately managed accounts (SMAs) to ensure clients directly own all assets for probity and security.

David Llewellyn-Smith

David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.

He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.

Latest posts by David Llewellyn-Smith (see all)

Comments

  1. There will always be suckers.

    I’d drink a schooner of cold jism rather than seek advice from a financial adviser.

  2. Since these securities are listed, there should be some liquidity but many LICs trade by appointment.

    The only entrance cost is surely brokerage charge unless the buyer is taking an interest in an IPO, which would not be a good idea, give the likelihood of trading at a discount to NAV on market. Buying a LIC at a discount to NAV could work well if the sector began to trade at or above NAV as it has in the past. Some like Ryder Capital have performed strongly.

  3. Some of of the oldest LICs on the ASX have been around for 80+ years. Some are well managed and have performed well over the long term. Your observation could be a little more balanced.

    It is actually an ideal structure for fixed income type investments who hold lumpy ‘assets’, compared to open ended funds where liquidity can be an issue.

    There’s plenty to like about LICs. Many are trading at a discount now based on a hangover from Labor’s proposed cuts to franking and because active management has failed to outperform index management in this market. It’s not a bad time to pick up $1 worth of assets for $0.80 for some of these LICs.

    I do agree about the FoFA loophole, that needs to sort itself out. Is this financial adviser trying to Flog LIC IPOs though, or just recommend a portfolio of LICs for their yield. If the latter, there’s no issues with this.

    • “There’s plenty to like about LICs. Many are trading at a discount now based on a hangover from Labor’s proposed cuts to franking..” – I am not going to argue about the rest of your comment as you might be right and I don’t understand LICs at all. But this particular line makes no sense at all. Once such threat was removed prices should have recovered in an instant as with any other listed company that had its share price under pressure due to possible impact from legislation change or court case or pending drill results that some suspected may not show solid grades etc etc.

    • Should someone whose risk profile is ‘fixed term deposit’ be investing in these kind of financial assets at all? I mean, 1 year total return of 7.4% median and 0.7% average indicate it’s not a low risk investment. Why would any financial adviser be pushing this if not for the commission?

    • Yes. ARG & AFI are as old as the hills, passive, low fees and steady 4%+ franked dividends.
      The newer ones are to be wary of.

  4. I agree this is not a balanced article and like shares, an LIC should only incur brokerage to buy and sell. Also, like shares and managed funds you still need to sort the wheat from the chaff.

  5. I’ve looked at some of these & a bit like many industry & retail super funds it’s quite hard to find out what they have actually invested in. Some seem to imply “lower risk” but then you find they’ve got illiquid investments in overpriced infrastructure somewhere else in the world! It’s quite funny that we’ve had all this legislation to “fix” the financial investment industry but it would appear that it’s more opaque than ever?

    • Liquidity is only ever a problem if you believe the investments in which you are involved are liquid, when they’re not. Some of the soundest investments in the world are also fairly illiquid and as long as the investor is aware that is all fine.

      During the GFC, when investors needed liquidity most, the worst performers (of the risk assets) were the most liquid ones. For obvious reasons. You can’t sell what you can’t sell.

  6. This has been a well known loophole in the industry for ages. Basically underwriting fees for the issue of listed securities isn’t subject to FOFA.

    Never buy an LIC or LIT on original issue.

  7. Sorry David but your comments are extreme and not very balanced. Try checking BKI which has fees lower than many ETF’s and a long history of reliable franked dividends. The same applies to Argo and AFIC. There are many retirees that have based their investment portfolios on LIC’s successfully and certainly with the larger funds liquidity is not a problem and the same as any other listed share. The current large number of LIC trading at a discount appears to be cyclical and with careful selection may represent a buying opportunity and enhanced yield.

    • Or not. 80% under water…hmmm…

      KKR’s new fund (ASX: KKC) raised $925m from unsuspecting mums and dads and listed only on the 21st of November, has already torched $27m of their money with the price slumping from $2.50 at issue to around $2.42 today. It is trading well below NTA. So mums and dads who thought they were getting 4% above the RBA cash rate have lost 3% of their money in a couple of weeks…

      Just sayin, these are not plain vanilla securities and should not be sold as such on fat commissions.

  8. Advisers without any investment philosophy.

    Seriously, moving from a term deposit to a LIC? Next its Latrobe or IPO Wealth. When has a 60/40 portfolio and doing nothing not done the job?