The LIC/LIT "mis-selling crisis" is grossly exaggerated and the key issues widely misunderstood

The issues around performance of LICs/LITs, which is impacting the debate on stamping fees, should be addressed fairly and objectively, not by flawed analysis, aggressive lobbying by industry participants or sensationalist media coverage.

Proper returns analysis of LICs/LITs (and LICs in particular), is more complex and nuanced than many perceive and needs to be multi-dimensional. A range of mistakes can easily be made and ASIC’s recent analysis, made available as part of a Freedom of Information (FOI) request by the AFR, and the basis of advice to Treasury/Government, has made most of them.

Simple analysis of share price plus raw dividend returns to 30 June 2019, which has been the basis for ASIC’s case for poor performance of 48 LICs/LITs listed since 2015, is obviously relevant to investors, but is far from the full picture. Further, there are some major errors in ASIC’s raw numbers which significantly distort the results.

The multiple complexities of LIC/LIT performance

There are multiple dimensions to LIC/LIT performance that have been largely or totally ignored in the ASIC analysis and the media commentary surrounding it.

Firstly, share price plus dividend return is driven not just by underlying NTA return (what the investment manager delivers less fees and tax in the case of LICs) but by the starting and ending price relative to NTA (i.e. discounts/premiums) and is very sensitive to ending discounts. Neglecting these dynamics and looking at investor experience at one point to point time period can result in a misleading judgement on longer term investment performance. Indeed, because of this discount/premium factor, past performance of LICs, more so than other fund structures, is typically a poor and usually contrarian, indicator of future performance.

Secondly, because of tax paid and payable, a larger part of a LIC’s return is typically franked dividends so a simple comparison with unlisted funds/ETFs without considering the different taxation arrangements is inappropriate and can understate LICs returns. LICs also usually have franking credit balances reflecting previous tax paid that can benefit investors in the future. This contrasts to unlisted funds that typically have a large unrealised, but largely hidden, capital gains tax liability which will eventually be distributed and taxed in investors hands, lowering after tax returns.

Thirdly, some of the LICs/LITs listed since 2015 involved an initial issue price at a premium to NTA of 3-4% because investors paid all the costs of the issue (stamping fees were part, usually around one third to one half of these initial costs). Investors in LICs/LITs started with this additional drag on performance compared to an unlisted fund or ETF. More recently, managers of LICs/LITs have met this cost, a significant and welcome improvement on prior LIC/LIT investor experience, and this has become the standard model of LIC/LIT capital raising today meaning investors now typically don’t pay any initial costs, including stamping fees, and have the benefit of a starting NTA equal to the issue price. It should also be noted that some recent offerings, MHH and VG8, have provided IPO participants bonus units or shares in the listed manager (as well as paying issue costs) such that investors are effectively buying in at a discount to the issue price/initial NTA.

Fourthly, in the case of around half of the 48 funds listed since 2015 in the ASIC analysis there were listed options attached as part of the IPO. ASIC have ascribed no value to the ability of investors to realise value by selling these options on market or in exercising those options that were “in the money” on or before expiry. Importantly, in cases where options were in the money and exercised, those investors received a return benefit by being able to purchase at a price below market, although NTA would have suffered dilution from these option exercises, which would drag down performance as measured by the share price alone. This has been ignored by ASIC and by other assessments of LIC performance.

Fifthly, in many cases advisers rebate part or all the stamping fees to investors so the effective return since inception has been higher by the amount of this fee rebate. (Stamping fees are typically 1-2%, not the much higher levels some media commentators have been quoting). It is difficult to determine the amount of rebating that goes on but it seems to be significant amongst financial planners and is likely to increase under stronger enforcement of the investor best interest duty and the FASEA Code of Ethics that came into effect from 1 January 2020.

Sixthly, ASIC make a point that LIC/LITs have significantly higher fees than ETFs yet have “underperformed”. Almost all active funds (listed and unlisted) have significantly higher fees than passive funds/ETFs, and in recent years active funds on average, irrespective of the fund structure, have underperformed the market indices and ETFs that track them. This is only part of the picture. Interestingly, despite the importance of judging performance of the LIC/LITs since inception nowhere does ASIC provide ETF or market index numbers that equate to periods since listing for each of the funds. (providing 1-year and 5-year numbers only).

Finally, and related to the previous point, the ASIC analysis of 48 funds simply looks at raw absolute performance and not against their own relevant benchmark. Many of the LIC/LIT funds that have listed since 2015 adopt specialist investment strategies including long/short, market neutral and income focused. These strategies generally aim to have a lower risk profile than equity markets, would be expected to lag in a strong sharemarket and should not be naively compared to equity markets or equity ETFs.

Related to this, risk in listed closed end funds is also partly dependent on the current discount/premium to NTA, and in almost the opposite way that investors perceive. Investors seem to only perceive discounts as an additional risk of the LIC/LIT structure, but once a fund trades at a discount, especially a large one, it’s return profile from that point is more positively asymmetric (all other things equal). A fund that has moved to a discount may show poor returns looking backwards but that bigger discount usually means the risk of further poor performance is reduced and the likelihood of good performance higher. This needs to be considered in any “point to point” performance comparison, especially if the end point is a period of above normal average discounts, as is the case with the ASIC analysis which ended in mid-2019 when LICs in particular were still suffering from earlier concerns of possible franking credit changes and end of financial year tax loss selling.

Rebound in numbers ignored

If ASIC had updated their analysis (according to the FOI material they were still using the same 30 June 2019 figures in PowerPoint presentations dated as late as 27th November 2019) it would be clear that many of the funds that were the worst performers since inception and over 1 Year to June 30, 2019, have actually had particularly strong performance since. The table below shows the subsequent performance of the 10 worst funds as defined by the ASIC analysis (excluding the ASIC errors/exclusions described below) for the 6-month period between June 30 to 31 December 2019. The commonality of funds in ASIC’s worst 10 since inception and the 1-year numbers shows their sensitivity to end discounts. This mean reversion tendency of discounts that contributed to these improved returns is a key differentiating characteristic of listed closed end funds.

Interestingly, at the same time the AFR was breathlessly reporting the ASIC LIC/LIT performance analysis, fund manager Hugh Dive wrote an AFR opinion piece “Shifting through the trash for stockpicking treasure” which opened “The greatest returns on the stock market rarely come from buying the well-loved stocks whose share prices have performed strongly, but rather from unloved companies that outperform expectations.” Many recently discounted LICs fit into the latter category.

Of course, there are some exceptions to this mean reversion tendency. Some poorly managed funds can continue with even worse performance, higher discounts and very occasionally there are funds subject to fraudulent behaviour that results in total or near total loss (see the pirate funds below) but it’s not as if the unlisted fund space is immune from such problems.

Some of the ASIC data is wrong, and not in a minor way

Even if one totally ignores the range of complex issues around assessing LIC/LIT performance discussed above and accepts ASIC’s simplistic, point to point approach to LIC/LIT returns, there is a fundamental problem that some of its key data is simply wrong, and by major margin. Most concerning is that three of the funds that ASIC data highlight as amongst the worst performers since inception were far from it and using correct figures changes the ASIC result significantly.

Three funds that ASIC got the since inception number wrong in a major way are,

• NGE (NGE Capital Limited) - this was a conversion of an existing company to a LIC in November 2016 and ASIC show it with a return since inception of -42.0% while the fund actually returned +52.6% to 30 June 2019 and has been one of the better performing LICs on the market.
• AYZ (Australian Masters Yield Fund Number 5) is a LIC that invested in Australian corporate bonds and has been in wind down and is shown with a return since of -56.9%. Yet it seems no account has been taken of the capital returns and dividends paid in that period. Conservatively adjusting for these capital returns and dividends (i.e. assuming no reinvestment) results in a return since inception of +11.8%.
• SEC (Spheria Emerging Companies Limited) is a LIC that listed in November 2017 and is shown with a massive negative return of -97.0% since inception and an end price of zero from a $2 issue price. While SEC’s value style has not been in favour, actual returns since inception to 30 June 2019 was just -7.5% including 6c cents in franked dividends and incorporating a move to a mid-teens discount to NTA. (Disclosure - I own this fund currently and believe it is an attractive investment opportunity at the current 15% discount).

One other problem with ASIC’s numbers is it is not clear where the -6.1% average return since inception came from. .Even before any adjustments to their own spreadsheet, it seems the average return since inception on 48 funds is -4.5% not the -6.1% in the ASIC presentations. The -6.3% for 1 year seems consistent.

In any case, correcting returns for just the three funds discussed above changes the since inception number in the ASIC analysis for the 48 LICs/LITs to +0.7% (compared to ASIC’s -6.1% and the spreadsheet number of -4.5%). The 1-year number remains in line with ASIC at -6.3%.

It should also be noted ASIC analysis of LICs/LITs throughout assumes no reinvestment of dividends or capital returns as is usually standard for fund performance calculations. This would generally understate the LIC/LIT returns, especially since inception, but to keep things simple I have adopted the same approach in the adjustments above.

Pirates blast more holes in ASIC analysis

But wait, there’s more. Complicating the analysis further are the two pirate themed funds (HML and BHD) which the ASIC FOI material describes as frauds and which are now delisted.

Being delisted, but still in existence, the ultimate outcomes for these two funds are unclear although it doesn’t look good for investors. ASIC has assumed a zero end value for both funds which, once dividends are included, gives an investment return of -80% for HML and -88% on BHD since inception.

ASIC has also used the same -80% and -88% returns for HML and BHD respectively over one year to 30 June 2019 despite HML not having traded since June 2017 and BHD since July 2018.

There is no doubt that these two funds have been disasters for investors although there were some clear early red flags. (I tried to warn some investors off these funds in mid-2017 and wrote about them in a late 2018 Livewire article “Looking out for pirates in LIC land”. Perhaps if ASIC had been more proactive, HML and BHD wouldn’t have morphed into the pronounced and prolonged shipwrecks they became.

In any case, given fraudulent funds are a rarity in the LIC/LIT space, I believe they should be excluded from the analysis if one is primarily trying to understand returns from legitimate offerings, and the implications of stamping fees, in the LIC/LIT space. Certainly, it seems odd to also include them in the one-year numbers (with the same numbers as since inception) when HML did not trade at all and BHD for only one month of that period.

Therefore, if we now correct for the three major ASIC errors above (NGE, AYZ and SEC) and also exclude the two pirate fund frauds HML and BHD, then under a simple analysis of 46 LICs/LITs that IPO’d since 2015 the returns since inception to 30 June 2019 is actually +4.4% (compared to ASICs original figure of -6.1%) and -3.0% over the one year to 30 June 2019 (compared to ASIC’s -6.3%). These are summarised in the tables below.

The change in the since inception number is very significant given poor returns since IPO is the core tenant of ASIC’s criticism. In a presentation by ASIC Senior Executive Leader Market Supervision, Calissa Aldridge entitled “A fair strong and efficient financial system for all Australians” the only non-redacted slide included only one return related dot point saying, “Poor performance – overall aggregate returns -6.1%.” In my view this should be at least +4.4% and far from the disaster parts of the media have painted.

Some might counter that even the corrected performance numbers are still subdued in absolute terms. However, these numbers don’t include any adjustment for the other complexities of LICs/LITs discussed above (including simple reinvestment of dividends). Moreover, they are still substantially understating/distorting LIC/LIT returns because they are not adjusting for issues including option dilution, different tax structure/higher franked dividends, the change in the IPO upfront cost model from “investor pays” to “manager pays”, stamping fee rebates or properly incorporating the implications of movements in discounts/premiums.

One should also note that the median time since listing of the 46 funds covered is only around 2 years. As I discuss further below this is far from the ideal time period to assess performance of LICs/LITs given the typical, albeit far from certain, move to a discount over the first 1-2 years.

Fortunately, there are few true pirates in LIC/LIT waters

In contrast to the impression from some media commentators, the idea that LIC/LIT IPO are frequently paying high stamping fees of 3% plus and as high as 6% is simply false. Even according to the ASIC analysis of 48 IPOs since 2015, 69% of the funds had stamping fees of 1.5% or less and 92% had stamping fees of 2.5% or less. i.e. only 4 of 48 funds had stamping fees higher than 2.5%. As noted above in some cases these stamping fees were paid fully or substantially to investors via rebates.

It is no real surprise that the two pirate funds account for two of the four stamping fee outliers with HML at 4% and BHD at 3%. One of the other two outliers is MMJ at 5% (an existing listed company converting to a LIC in 2018 and holding a collection of cannabis related investments. However, as far as I can see the 5% stamping/selling fee applied to a capital raising before the fund converted to a LIC.

The last outlier is LRT at 5.5% (a small resources unit trust that converted from an unlisted trust and raised a minimal $3.5 in the listing process in early 2018 - that’s a maximum total stamping fee of around $192k).

Given the unique circumstances and small scale of these 4 stamping fee outliers, I believe they should all be excluded from the analysis as not being representative of the standard stamping fee arrangements in the LIC/LIT sector. Clearly, any LIC/LIT raising money today would not have stamping fees anywhere near these levels.

One of ASIC’s conclusions is that LIC and LITs with stamping fees underperform those without them on average. According to ASIC, since inception, funds with stamping fees returned -7.3% while funds without stamping fees returned +3.0%. For one-year ASICs figures were -7.0% and -1.9%.

This is one of the few conclusions from ASIC’s analysis that does stack up, and once ASIC’s error on NGE corrected, on the since inception number, even more clearly than their own numbers suggest. The 6 funds with no stamping fees were OPH, AGM, EAF, FOR, NGE and RYD. When you correct for ASIC’s errors on NGE, the average return since inception for those with no stamping fees since inception jumps to 18.7%.

Having said that, given only these 6 of the 48 LICs/LITs didn’t have stamping fees, and 5 of those 6 were conversions of existing listed entities across widely divergent strategies, I would suggest it is simply too small a sample to draw any sensible conclusions.

Should stamping fees be capped? Perhaps, it would certainly more definitively prevent outliers like the four discussed above but if capped at a level of 1-2% this would be broadly in line with where most of the industry already is.

ASIC’s key charts ransacked by errors and pirates

The core of the ASIC PowerPoint presentation is three charts that purport to show;

1. A correlation between the level of discounts and the level of stamping fees. Slide 5 “Conflicted Selling Incentives and Discounts to NTA”
2. A correlation between stamping fees and 1-year performance to mid-2019. Slide 6 “Conflicted selling incentives and Recent Year investment outcome”
3. A correlation between stamping fees and returns since inception. Slide 7 “Conflicted Selling incentives and Investment Outcomes since Inception”

With performance numbers corrected for errors, and the sensible exclusions I suggested above, I believe ASIC’s charts and numbers prove none of these correlations/conclusions with any conviction.

The first ASIC chart “Conflicted Selling fees and discounts to NTA” attempts to show that higher stamping fees are correlated with bigger discounts to NTA.

However, if you take out the two stamping fee outliers (MMJ and LRT, HML and BHD are already excluded) then it is difficult to see any significant correlation as ASIC suggest. Interestingly, NGE which had no stamping fee, and was one of the best performers since inception, traded at one of the larger discounts to NTA at 30 June 2019.

The second chart “Conflicted Selling Incentives and Recent Year Returns attempts to show a correlation between stamping fees on the Y axis and investment returns on the X axis for the one year to 30 June 2019. However, if you correct for ASIC errors and take out the four outlier stamping fees of 3% or higher there doesn’t seem to be any correlation. Indeed, the worst one-year return outcome came from a fund with no stamping fee, FOR with -39.4%. FOR was a conversion of an Australian unlisted trust to a LIT.

ASIC’s third chart “Conflicted Selling Incentives and Investment Outcomes since Inception” looks at the same relationship since each fund’s inception. “However, again if you correct for the three major ASIC return errors and remove the 4 stamping fee outliers, visibly there is little if any relationship between the size of stamping fees and investment performance.

Clearly, few robust conclusions can be drawn from these charts, even before properly considering some of the other complexities of LICs/LITS raised above.

Discounts/premiums - the waves that complicate the LIC/LIT return story

Clearly, a large part of performance since listing in the ASIC numbers was the move, since inception, of many funds from trading at NTA or a premium to NTA (if investors paid the initial costs) to a discount at June 30, 2019. (Average 10.7% discount on ASIC’s numbers).

It is no real surprise that LICs and LITs typically tend to drift to a discount in the 1-2 years after listing. Irrespective of whether stamping fees are paid or not (or rebated to investors) there is a degree of promotion required to get a LIC off the ground in the concentrated capital raising period required and in this process some investors tend to purchase with only limited understanding of what they are buying. When the initial enthusiasm wanes there tends to be a period where selling pressure overwhelms new buying interest, unless the manager/board does an exceptional job marketing the fund to new potential investors. (As noted above the median period of listing in the ASIC analysis is only around 2 years).

Many investors and commentators, and even fund managers, misunderstand the reasons for, and nature of, fund discounts. On 3 January Chris Joye in an AFR article “Frydenberg faces up to mis-selling crisis” wrote “ Managers regard LICs and LITs as especially attractive because they have very high fees and provide permanent capital that cannot be redeemed which is why they often trade at a substantial discount to their Net Tangible Asset value (NTA)”

High fees may contribute to some funds trading at a higher discount (although ASIC data doesn’t make such a case) but the explanation for discounts more broadly is much more nuanced. Indeed, there is no such thing as “permanent” capital in the LIC/LIT space – “semi-permanent” perhaps. Managers that don’t perform in the medium to longer term, or boards that fail to manage capital well for shareholders, will eventually be replaced or terminated.

While investment management fees on some LICS/LITs could be lower, particularly since investors are locking up capital and taking on the discount risk, the view that LIC and LITs are a near risk free, business gravy train for fund managers is misguided. After 1- 2 years of listing most managers and boards realise that to run a fund well they need to perform from an investment perspective, market the story well and manage capital efficiently. The higher public profile of these vehicles and the tendency of activists to bring reputational risk to managers that don’t deliver on these levels creates considerable challenges that most fund managers and boards seriously underestimate at IPO.

Several funds have recently responded to the pressure of trading at persistent discounts by announcing actions to convert to unlisted trusts or active ETF structures e.g. MA1, EGI, two Watermark funds. There have even been wind-ups such as the case of 8EC. The potential for the introduction of such discount narrowing/elimination measures is one reason why the return outlook for LICs/LITs is more positively asymmetric, and risk lower, once a fund is trading at a large discount.

The listed closed end structure is different, with different issuance arrangements and unique features and benefits

Discounts and premiums are one of the key distinguishing features of the listed closed end fund structure. This structure comes with a range of benefits not available to unlisted, open ended structures. For example, the closed-end nature provides more certainly of the asset base and a lack of vulnerability to inflows/outflows that allows the manager to invest in ways impossible, or more difficult, for open ended unlisted funds.

LICs/LITs can be fully invested without cash drag, or even geared if appropriate, without

the usual fear of being forced to sell assets at the wrong time. They are a more robust vehicle to invest in less liquid listed assets or in illiquid assets for similar reasons, while still providing the secondary market for those investors who require liquidity themselves.

LICs also provide greater ability of the manager/board to control and smooth dividends, a valued benefit for many shareholders, especially retirees.

There is also the ability of the listed closed end structure to manage capital efficiently and reward patient, long term investors by adding value/return through buying back shares at discounts and/or issuing shares at premiums. This is a tool that is not in the arsenal of unlisted funds.

Of course, there are some disadvantages of LICs. For example, they generally don’t have access the capital gains tax discount (Although LITs may). The tendency to trade away from NTA is another “disadvantage” although depending on your perspective, this can also be an advantage and opportunity.

The listed closed end structure usually can only come into existence however, through the concentrated short-term capital raising arrangements that applies to all listed companies.

A more holistic view of stamping fees/conflicted remuneration on listed investments is required

The costs of new issues of all listed securities have always been paid through a one-off approach given the concentrated capital raising period. Stamping fees are one element of these initial costs. This concentrated capital raising approach puts time and assessment pressures on advisers/stockbrokers considering the investments for client portfolios, whether they be company securities, hybrids or property, infrastructure or investment funds.

Without compensation to meet the costs of groups who operate primarily or totally on a transaction basis, a significant hurdle is erected for quality, specialist managers seeking to access the benefits of the listed closed end investment structure for their investors, in the same way that smaller less well-known companies would have greater difficulty raising capital without stamping fees.

Of course, I suspect there are a few rogue stockbrokers or advisers that are mis-using LICs/LITs and even contributing to larger discounts and poorer short term returns by driving some of the short- term, post IPO selling for irrational and sometimes unethical (churning) reasons. Most of these vehicles are meant to be long term investments, with listing providing a liquidity option for those that need it. ASIC is right to recently flag that it will increasingly conduct ongoing audits of stockbrokers and advisory group assessing the ongoing actions around LICs/LITs beyond the IPO phase to assess the basis for recommendations.

However, ASIC should be thinking a few steps ahead about any proposed structural changes. If LIC/LIT stamping fees were banned yet they remained on a range of other listed securities, those few less scrupulous brokers/advisers that are chasing and abusing such fees will simply change the way they build portfolios and find ways other ways to game the system and exploit clients such as using more securities where stamping fees still apply or simply churning their portfolios more across secondary issues.

ASIC might argue that the client best interest duty should prevent such behaviour as should the recently introduced FASEA Code of Ethics. However, shouldn’t those obligations also be the case whether stamping fees are in place on LICs/LITs or not? i.e. Shouldn’t we allow client best interests duty and commitment to ethical behaviour drive decisions around whether advisers/brokers receive some or all these stamping fees or instead rebate them to clients, particularly with most stamping fees in the 1-1.5% range?

If an investor was paying an annual advice fee to a financial planner or wealth manager and they recommended a LIC/LIT IPO, client best interest would suggest that any stamping fee should be fully or largely rebated to the client. But could a stockbroker whose business relies largely or exclusively on transaction fees and other financial services group groups that are making the fund available directly to clients be justified in receiving a small stamping fee for the work involved in orchestrating the concentrated nature of these closed-end, listed offerings? I find that hard to argue against, particularly while stamping fee arrangement remain in place for all other closed end listed investments and listed companies.

Focusing on the right issues

The intention of the original “carve out’ in the law was to distinguish between companies that pay stamping fees “to secure debt and equity capital for productive companies” that “made goods and provided services”. What about a LIC that only invests in private equity or a LIT that only invests in private debt? Aren’t they providing new debt and equity capital for businesses that “made goods and provided services”?

What about AREITS which along with LICs were originally planned to be excluded from the carve out? or infrastructure funds? or hybrids? What about an internally managed investment conglomerate such as SOL?

If stamping fees around LICs and LITs are now to be reviewed again then perhaps so should stamping fees on all listed securities because they are all used by advisers and stockbrokers to build client investment portfolios.

Where is the ASIC analysis and discussion on these issues? Instead, partly due to lobbying and media pressure, they have pursued a relatively small segment of the investment universe by providing a simplistic, backward looking, flawed analysis that fails to appreciate the unique aspects of the LIC/LIT structure and the origination process that brings them about. ASIC has also failed to provide any forward assessment of how adviser behaviour would change, and consumers be impacted, in a lopsided world where stamping fees are payable on some closed end listed vehicles and companies, but not others.

The listed closed end investment structure exists because it has long term benefits to investors and has stood the test of time. The structure has been around in Australia for almost a century and considerably longer in some other countries.

Meanwhile a range of other conflicted remuneration arrangements remain firmly in place

If ASIC and the Government are truly concerned with eliminating conflicted remuneration in the fund space, perhaps it should re-examine some of the remaining, more pervasive and anti-competitive conflicted remuneration arrangements in financial services. For example, fund manager sponsorship of adviser conferences and “education” programs, some platform arrangements or even the “pay for ratings” research house model.

This fund manager financed, “pay for ratings”, research house model has influence over a much broader array of investment products compared to the $50billion in LICs/LITs. Fund managers pay research houses to research/rate their product and this research/rating is then used by financial advisers to support product recommendations to investors.

Advisers/licensees benefit from this conflicted payment by generating more profit than they would otherwise by relying on fund manager subsidize research rather than either building the in-house resources to do the research themselves or paying an “independent”, non-conflicted party do it. This conflict, along with some others, has been put in the “too hard” basket by ASIC for many years now.

Conclusions

Have there been a lot of complaints about stamping fees on LIC/LIT IPOs from investors? (and not just certain financial services groups and sections of the media). As provided in the FOI material an ASIC Senior Specialist stated via email in August that “we weren’t able to extract complaints due to that level of granularity.” This looks like a case of media (and lobbying) pressure pushing ASIC to conceive and grow a problem that didn’t exist or was much smaller than was being made out. Today that offspring is making a lot of noise but not being constructive for anyone.

Indicative of this pressure from competitors, it is notable that in one of the earlier ASIC presentations, dated 12 September 2019 , there was an additional slide 11 titled “Industry research by Stockspot” simplistically promoting the case for ETFs over LICs. The Stockspot paper behind the points on that slide contained many of the same flaws as the ASIC analysis (e.g. not accounting for tax differences, options or risk etc.).

The ASIC analysis and competitor and media commentary around it has clearly missed the complexities and nuances of LICs and LITs. The same Senior Specialist for ASIC stated via email in August that “It is hard, on the historical data available, to justify maintaining the stamping duty exemption from conflicted remuneration for these products.” However, if a case is to be made for banning stamping fees on LICs/LITs it should be based on analysis that is objective, broad in scope and reliable, not just backward looking, overly narrow and flawed. Proper assessment of LICs/LITs returns is difficult, and errors easy to make, but this means judgements and policy decisions need to be approached cautiously.

Are there some LICs/LITs that will perform poorly in the years ahead? For sure. Do investors need to be cautious buying into LIC/LIT IPOs, particularly “flavour of the month” asset classes or managers? Definitely. Are there some funds whose share price will move from trading at NTA at IPO to 10%, 15%, or even 20% plus discounts in the future, showing disappointing returns, at least in the short/medium term? For certain. Will such moves provide some attractive investment opportunities? Almost certainly yes. Will there be more frauds like the pirates? Hopefully not, if ASIC and the industry do a better job of vetting them out.

Does any of this mean the LIC/LIT structure is flawed and investors generally have been systematically mis-sold the LIC/LIT concept, even with modest stamping fees being paid? No.

Can poor absolute performance occur in unlisted funds and ETFs? Of course. Could LICs and LITs, properly adjusted for tax and other differences highlighted above, significantly outperform unlisted funds/ETFs in the next few years, especially from recent above average discounts and in more difficult market conditions more supportive of the value and specialist/income strategies more common in LICs/LITs? That outcome must be a reasonable probability.

This excessive focus on LICs/LITs raises the chances the industry is neglecting other products where the risks of permanent losses are high. Spare a thought for unsophisticated investors who pass the outdated and feeble hurdles of ASIC’s wholesale investor tests and continue to be drawn into some deeply flawed unlisted products such as IPO Wealth/Mayfair Platinum, whose forward looking risk/return profile and liquidity mismatch is much more concerning than the vast majority of the LIC and LITs listed in recent years (pirate funds excepted) and despite these products targeting conservative investors. See “IPO Wealth/Mayfair Platinum – the scary end of the rush for yield” December 2019.

Rather than a toxic battle between supporters of different fund structures, financial services participants need to better understand and appreciate the unique characteristics and advantages and disadvantages of each, aiming to develop a healthy industry framework for all. This allows for a greater industry focus on creating products that deliver for investors and weeding out poor quality ones, irrespective of the fund structure. In today’s emotive and time-consuming discussions about competing structures (and LICs/LITs in particular) this crucial focus is being neglected, with investors the ultimate loser.

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Dominic McCormick is an independent investment consultant. Amongst a range of roles across the investment industry, Dominic has also recently been contracted by LICAT to provide independent commentary and input on issues impacting the closed end listed investment fund space. LICAT has no editorial control over the content of any articles written under his own name and Dominic has not been paid by LICAT or any other party for this Livewire piece.