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Home Supply Chain Updates

LICs in the spotlight over returns

usscmc by usscmc
November 19, 2019
LICs in the spotlight over returns
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Morningstar data director Greg Bunkall says performance reporting by LICs is a “rabbit hole” due to the various ways returns can be measured and presented.

“We always think performance should be shown after all fees and expenses on marketing material, especially to a retail audience,” he adds. “The managed fund industry has done a better job than the listed fund community settling on a performance methodology that is consistent.”

No universal standard

WAM’s investment update shows that in the 12 months to end-October
the WAM Capital portfolio underperformed the S&P/ASX 200 All Ordinaries Accumulation Index. Over three years, its portfolio underperformed both this index and the Small Ordinaries Accumulation Index.

Across five and 10 years, WAM Capital outperformed by between 4 per cent and 9 per cent annually, as well as strongly outperforming since its 1999 inception, according to Wilson’s investment update.

Nevertheless, these figures exclude the fund’s expenses and fees of at least 1 per cent annually that investors ultimately pay, so retail investors cannot easily decipher precisely how their investments have performed against the benchmarks.

The broader point is there is no universal standard for how listed funds report their investment returns and whether they should deduct fees, expenses and taxes.

The Australian Securities Exchange, in consultation with the Australian Securities and Investments Commission, is conducting a review called “Simplifying, clarifying and enhancing the integrity and efficiency of the ASX listing rules”, including reporting by listed funds.

ASIC’s Regulatory Guide 53 says promotional material citing past performance using gross returns may be misleading and returns should be net of fees “to the greatest extent practicable”.

“Where it would be misleading or impracticable to deduct some fees, the existence of such fees should be prominently disclosed,” ASIC says.

Easier for retail investors

LICs have been able to work around these rules that are more rigidly imposed on unlisted managed funds.

But Wilson, who gained a high profile campaigning against Labor’s proposed election tax crackdown on refundable franking credits, says he complies with ASIC Regulatory Guide 53 by disclosing both gross and net of fee returns in conducting capital raisings.

Some LICs exclude fees, expenses and company taxes which also significantly overstates investor outcomes.

— Chris Brycki, Stockpot CEO

Argo Investments and AFIC, two of Australia’s oldest and biggest LICs, disclose their portfolio performance after deducting management fees, expenses and tax.

Both are benchmarked against the S&P/ASX 200 Accumulation Index. AFIC assumes an investor can take full advantage of the franking credits.

WAM’s private accounts filed to ASIC reveal it collected $35 million in management and performance fees across its six funds last financial year – representing about 1 per cent of the $3.5 billion managed by WAM.

WAM incurred expenses of $22 million for staff, rent, administration and depreciation.

Incorporating these types of fees and expenses into the fund’s disclosed annual net return tables against its market benchmarks would help retail investors understand the full extent of how they are faring financially.

Lonsec head of listed products Peter Green says where LIC managers elect to disclose their returns on a net tangible asset (NTA) basis, the best practice is to do it post fees.

“Fees can make a big difference,” Green says. “Returns should always be reported after fees because that’s what the unitholder or shareholder gets.”

Three measures

Wilson says his monthly tables comparing performance with market benchmarks “clearly state it’s before fees, expenses and tax”.

“People know we charge a 1 per cent management fee and our expenses historically have been about 0.20 of a per cent depending on the fund.”

He points out that in WAM’s official financial reports published every six months, the funds report returns in three ways: the gross performance of underlying stocks (net tangible assets or NTA); NTA return after fees and tax; and total shareholder return (effectively the LIC share price movement, dividends and any capital adjustments).

“We use all three measures,” Wilson says.

“As the investment manager of an LIC is driven towards ‘beating’ a benchmark index over time, investment portfolio performance is the true measure of the ability of the investment manager to fulfil this obligation to investors.

“It is important to compare apples with apples in order for investors to assess the investment manager on their ability to fulfil this obligation.”

At WAM, only the gross NTA, labelled by the “investment portfolio” (before fees, expenses and taxes) appears in a full annual performance comparison table against the fund’s benchmarks.

Page 8 of the annual report has a total shareholder return (TSR) graph, showing that $10,000 invested in the fund at inception in 1999 would have grown to $130,144, compared with $54,038 in the S&P/ASX All Ordinaries Accumulation Index.

The TSR measurement includes the effect of fees and expenses because the market should efficiently price these into the LIC trading price.

Fuller and more prominent disclosure of these TSR performances against annual market benchmarks, including in monthly investor updates, would appease some of the concerns of independent investment consultants at Morningstar and Lonsec.

WAM notes the TSR measure “does not value the potential benefit of franking credits distributed to shareholders through fully franked dividends”.

Some reports ‘too generous’

Wilson says LICs are different from managed funds because LICs pay tax and pay out higher fully franked dividends to investors, so post-tax returns can understate the returns of LICs versus managed funds.

“If you get the franking back, then it’s important,” Wilson says.

Chris Brycki says it’s not uncommon for LICs to use gross NTA plus grossed-up franked dividends and, sometimes, tax paid. AFR

About 60,000 of Wilson’s investors are low-taxed self-managed superannuation funds, which typically benefit from refundable franking credits.

Stockpot chief executive Chris Brycki, who advocates low-cost index investing, recently received inquiries from perplexed investors when he published analysis showing the performance of LICs was not as strong as some funds reported.

Stockpot’s analysis of LICs shows managers often report and present their performance in the most generous way possible. Brycki says it’s not uncommon for LICs to use gross NTA plus grossed-up franked dividends and, sometimes, tax paid.

“This massively overstates what most investors have earned,” Brycki says. “Some LICs exclude fees, expenses and company taxes which also significantly overstates investor outcomes.”

More broadly, the complexity of LIC reporting is amplified by the sharemarket price of LICs often trading at a significant discount or premium to the underlying NAV.

The price the funds trade at on the ASX is the relevant price investors can buy and sell at, rather than the NAV.

“Our view is as a shareholder you get the share price performance, because that’s what you get if you sell,” Lonsec’s Green says.

Scrutiny deserved

Stockbroker Bell Potter’s analysis of 31 popular LICs shows 24 are trading at a discount.

“LICs that have provided unsatisfactory returns and are trading at substantial discounts to NTA have been under scrutiny recently, and in many cases the scrutiny has been more than justified,” Bell Potter analyst Will Gormly notes.

WAM Capital, one of the top performers, is bucking the trend. It’s trading at a pre-tax premium of 16 per cent to NTA, indicating strong market confidence in its performance.

The $274 million WAM Research fund enjoys a 17 per cent premium and $204 million WAM Microcap has a 4 per cent premium, according to Bell Potter.

On the other hand, the $453 million WAM Global is trading at an 11 per cent discount and the $925 million WAM Leaders trades at a 5 per cent discount.

The ASX is consulting on listing rules to “improve reporting by investment entities”. “The methodology for reporting investment performance should be considered holistically across all the different types of investment vehicles in the Australian market, including LICs/LITs, ETFs, quoted managed funds, and unlisted and unquoted managed investment schemes,” an October ASX consultation paper says.

The ASX and ASIC will make announcements in 2020.

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