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Trust and why not all LICs are created equally

The primary focus of the Financial Services Royal Commission to date has been consumer lending, financial advice and small-medium enterprises, but the investment management industry may also be lacking in public trust.

A survey in November 2017 by the CFA Institute called “The Next Generation of Trust – A Global Survey on the State of Investor Trust” highlighted some alarming signs that resonate here in Australia. The survey highlighted that trust in financial institutions is very low and the reputation of the finance industry compared to other industries remains poor. It also showed a widening gap between investor expectations and outcomes delivered. The map below shows the level of trust in the financial services globally. It is alarming to see that Australia has the equal second lowest level of trust after Germany at 31%. I suspect this outcome for Australia may be even lower today.

Trust in the Financial Services Industry: Reputation versus Realities

The survey asked retail respondents to rate seven actions that investment firms could take to build trust, ranked in terms of importance and personal level of satisfaction. The areas with the biggest difference between expectations and outcomes included disclosure regarding fees and conflicts of interest.

The CFA survey relates to the broader, and global, investment community. However, in the recent increase in Listed Investment Companies (LICs) in Australia, a key area of focus has been appropriate and consistent disclosure on the reporting of performance and fees.

Internally managed vs externally managed LICs

The traditional, internally managed LICs offer a low cost, transparent and stable but growing dividend for shareholders. In addition, management works for the company so there are no fees paid to an external manager nor any conflict of interest between the shareholder and manager. These LICs generally have a lower turnover and are considered an investor on ‘Capital Account’ for tax purposes as opposed to ‘Revenue Account’ firms which are considered traders.

Externally managed LICs offer a number of different strategies backed by some strong recent performance. However, the industry sometimes falls short in the reporting of consistent and relevant information for shareholders. Often what is disclosed are performance figures highlighting only a pre-tax portfolio performance, which can differ from the end-result to investors due to management fees, performance fees, dilution and taxes. Another often poorly disclosed factor is whether external fees are calculated pre-tax or post-tax. This makes accurate comparison between different LIC strategies difficult for retail investors.

This is an area where the ASX should assume leadership and create standard disclosure requirements for the LIC sector to ensure investors are fully and fairly informed.

Internalising IPO costs on new LICs

The recent trend for new LICs to internalise IPO listing costs (paid by the manager) is positive, as shareholders in the IPO have an NTA on listing equal to the issue price. However, the external managers are not doing investors a huge favour. Shareholders need to read the PDS/prospectus carefully, as the manager could be seeking to claw back these costs from shareholders over time through management fees and performance fees.

In addition, there are often onerous costs to break an investment management agreement, ensuring the manager will recover the listing costs with little risk. The primary attractiveness of LICs for external investment managers is the ‘captive money’ such an arrangement brings. While this guarantees the funds for future fee streams, it also removes the implications of money entering and redeeming from the fund, often at the worst times. Certainty of funding should allow for better investment decisions over the longer term. The importance of long-term captive money is intensified by fee pressure in the institutional funds management space and the internalisation trend being pursued by industry super funds.

What can Australia learn from the UK?

LICs have exploded in number and market cap over the last few years in Australia. However, they do go through cycles in terms of investor appetite and tend to trade on yield as much as NTA. The majority of recent LICs conduct financial reporting on ‘Revenue Account’ and many pay dividends from capital, usually realised gains. These gains may come under pressure in a market downturn, so investors need to be aware of the risk regarding the sustainability of dividends. Investors need to analyse where their dividend is coming from, and how much retained earnings the company has to support future dividends.

An interesting trend in UK investment companies has been the use of ‘continuation votes’, where a company’s articles of association provide for shareholders to vote on whether the company should continue to exist under certain circumstances. They give shareholders the opportunity to vote on a company being wound up. Some continuation votes are conditional on measurement metrics – say, when the discount to asset backing is trading wider than a pre-determined level for a period. Other continuation vote opportunities are offered on a periodic basis. Perhaps this is something that in time LICs in Australia could consider.

Survey recommendations

The CFA Institute survey also offered recommendations for the industry to increase investor trust through a ‘trust equation’ which is a combination of credibility and professionalism. Credibility addresses factors such as track record, brand, well credentialed people and the use of a code of conduct. Professionalism focuses on areas such as transparency and clarity regarding fees, competency, and values. Like any highly regarded service industry, trust and quality service should be the bedrock of a firm’s foundation.

Financial institutions are facing a challenging time with ethics and culture, as greed, dishonesty, and fraud appear to be occurring too often. The investment management industry is competitive. It is critical to provide appropriate products and transparent disclosure, and to ensure investors interests are put first.

About the survey

The Next Generation of Trust data collection was conducted by research firm Greenwich Associates and consisted of a 15-minute online survey conducted in November and December 2017. The survey sampled 3,127 retail investors (25+ years old) with investable assets of at least US$100,000 in the United States, Canada, Brazil, United Kingdom, France, Germany, the United Arab Emirates, Australia, India, Singapore, China, and Hong Kong. It also sampled 829 institutional investors with assets of US$50 million or more in these markets. The survey and related data is available at


Andy Forster is a Senior Investment Officer at Argo Investments Limited. This article has been prepared for educational purposes and is not a substitute for tailored financial advice.

Charts are Copyright 2018, CFA Institute. Reproduced and republished from “The Next Generation of Trust: A Global Survey on the State of Investor Trust” with permission from CFA Institute. All rights reserved.

Ex Advisor
June 15, 2018

LIC IPOs have become a gravy train for fund managers, advisors, brokers and the ASX. Given all the recent FOFA changes and limited normal IPO’s they have been an easy and large source of commissions. I am sure the Royal Commission would love to hear how advisors roll their clients from one LIC IPO into the other. Not sure that is in a client’s best interest. Feel this is part of the reason why many new LIC’s trade at discounts to NTA as the capital gets recycled.

Gen y
June 19, 2018

I’ve always wondered if the fofa carve out for commissions in IPOs may be looked at in relation to LICs. The only way LICs raise hundreds of millions in IPOs is through broker commissions. The carve outs were put in place to provide incentives for access to capital for Australian companies. Given LIC capital is only used to invest in existing companies and adds no real capital to markets, they’re exploiting a loophole here.

Steve Green
June 15, 2018

I eagerly await a continuation vote at ALI then in the next year or two.

Graham Hand
June 15, 2018

Hi John, Chris Cuffe recently wrote a comprehensive paper on the subject of poor LIC reporting, although whether it will be adopted is another matter:

John Derry
June 15, 2018

LIC reporting is shockingly bad; no wonder average investors can't trust it:

Fees - fees don't include operating costs, which easily double in small LICs. 'Total' costs and fees should always be disclosed in my opinion.

Performance - it is quoted in wildly different ways, manipulated by the usual suspects: pre fees, including option returns, NTA not share price return, assuming dividend reinvestment, assuming tax and franking etc, so that quoted returns are usually impossible for any shareholder to have achieved. 'Actual' shareholder returns and the underlying NTA performance are both important to know.

Benchmark - benchmarks are often imprecisely selected. Sometimes this is to the benefit, other times to the detriment of the LIC. For goodness sake, choose a benchmark that most closely reflects your strategy, not just the XJOA. This would save a lot of embarrassing explanations about underperformance when the truth might be that the LIC is weighted towards a particular sector/geography/style/size that is performing true to label.

Retained profits - why are LICs so silent on their dividend cover number that tells investors how many years ahead dividends can be maintained with retained profits - same with franking balance.

Why can’t someone write a white paper on this stuff and then get the industry to adopt it? ASX, ASIC and LIC industry association, where are you?

Gordon A
June 15, 2018

As a retail investor in LICs for over three decades I’m very disappointed with the LIC industry in general nowadays when it comes to fund reporting, commentary etc. Damn right dishonest at times. The new breed LICs have been the worst but even some of the low fee older LICs are becoming increasingly guilty of this no doubt having little choice if they are to compete with dubious reporting by others. Fortunately I know how to get to the truth but I pity the average LIC investor who likely accepts this commentary at face value.

It’s about time standardised reporting was introduced for all LICs so Trust can return to this sector.

June 14, 2018

Shareholder communication doesn’t mean trust. Why dont LIC’s put up their P&L at their investor presentations? As an accountant I struggle to reconcile quoted performance with financial performance in the annual report, though a lot seems to be explained by fees and costs.

June 14, 2018

Hi Geoff, I don't hear the ETF industry speaking as one voice. For example, some providers often criticise competitors whose ETFs are listed in Australia but invest in ETFs listed in the US and requiring extra paperwork for the investor.

Geoff Wilson
June 14, 2018

A very interesting article. A number of the points you make are of value to investors. Unfortunately a number of them are impacted by your biases as you have been influenced by your employment. For the LIC industry to continue to grow and prosper in a similar manner to ETF industry it is best that all participants provide unbiased commentary or none at all. I note with interest that Argo with its newest externally managed LIC ALI didn’t pay the cost of the raising and hasn’t installed a “continuation vote” even though ALI is trading at a large discount and has traded at a discount for a reasonable period of time.

June 15, 2018

Geoff - as a long term LIC shareholder and avid Cuffelinks reader I have seen plenty of articles being written by employees of your firm which I suspect may be influenced by their employment. I am perplexed as to why you are concerned, surely transparency and disclosure are a good thing? One of your employees previous articles highlighted “8 factors to consider when assessing LIC’s” which were all very valid, but failed to mention Fees, Transparency & Disclosure. Given this day and age surely “Trust” is a critical factor and on balance I think it is a good article, surely it is positive for an industry to critically analyse its shortcomings and improve as opposed to being cheerleaders. Continuation votes sound logical, ALI as well as many other LIC’s should consider one, as a good way to close the gap to their NTA.


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