Why Australia's LIC universe could shrink by 20% in two years

More listed investment companies (LICs) are likely to restructure as open-ended managed funds or active ETFs, a well-worn path that has seen the departure of nine LICs inside two years.

The Forager Australian Shares Fund (ASX: FOR) is set to become the next, following its announcement last week. In a statement to investors, Forager’s Steve Johnson indicated the decision came after ongoing efforts to improve the traded market price had failed to narrow the discount.

“The manager currently considers that the solution which will be in the best interests of FOR unitholders is likely to be the orderly transition of FOR back to an open-ended fund,” said Forager.

“Investor apathy towards closed-ended investment vehicles has become entrenched and ... smaller, less liquid vehicles like FOR are unlikely to trade at NAV for the foreseeable future,” the firm added.

A delisting proposal is expected to be finalised in the coming months, with further details set to be provided in the first half of 2024.

Affluence Funds Management’s Daryl Wilson, who runs a fund comprising around 30 LICs, notes that Forager is one of several that have been de-listed in recent years. The following have been restructured in the last two years alone:

• OzGrowth Limited ASX: OZG and Westoz Investment Company (ASX: WIC) – Merged with WAM
• Milton Corporation (ASX: MLT) – Merged with SOL
• Absolute Equity Performance Fund (ASX: AEG) – Merged with WLE
• Antipodes Global Investment – Converted to ETMF
• WCM Global Long Short (ASX: WLS) – Converted to ETMF
• Ellerston Asian Investments (ASX: EAI) – Converted to ETMF
• Magellan High Conviction Trust (ASX: MHH) – Converted to ETMF
• PM Capital Asian Opportunities Fund (ASX: PAF) - Merged with Wilson vehicle
• Templeton Global Growth Fund (ASX: TGG) – Merged with WGB

The first Australian LIC to restructure as an ETMF was the Monash Investors' Absolute Investment Company (ASX: MA1) in June 2021. After years of trading at discounts of between 10% and 15% and a series of attempted fixes, shareholders voted and it became the Monash Absolute Active Trust (ASX: MAAT).

“There’s definitely a broader trend at play and we think that’s going to continue. And when it’s all said and done, we’ll see between 15% and 20% of Australian LICs leave the space,” Wilson said.

“There are another 10 or 12 LICs where we see a reasonable chance of something happening in the next one to two years.”

Why are listed investment companies leaving the ASX?

Wilson says the moves are driven by a few factors, including the growing popularity of actively managed exchange-traded funds (ETMFs). He also notes that the transition to managed funds is easier for some types of LICs, particularly those focused on Australian equities.

“But the big reason is a lot of these LICs haven’t performed well and that’s ultimately what determines whether it will trade at a premium or discount [to net asset value],” Wilson says.

He believes the combination of underperformance by individual LICs and weaker market conditions have seen the discount rates increase.

“Discounts now are not quite at the worst we’ve ever seen them – they were a bit worse during COVID – but they’re probably the second-worst we’ve seen in seven or eight years,” Wilson says.

Rising shareholder activism

Investor activism is another factor that has driven some LICs to abandon the structure, which typically happens at smaller or mid-sized LICs where a small number of investors owning significant positions can push for change.

Wilson cites Magellan as a prominent example currently, with activist investor Nick Bolton owning 100 million options linked with the Magellan Global Fund (ASX: MGF).

The Absolute Equity Performance Fund (ASX: AEG) is another, the market-neutral vehicle merging with WAM Leaders in 2022.

“Ellerston has also taken two LICs off the market in the last couple of years, amid some urging from investors,” Wilson says. He believes a third, Morphic Ethical Equities Fund (ASX: MEC), may fold into either a listed ETMF or unlisted fund in the near future.

Is de-listing more suitable for some funds than others?

Some LICS are almost impossible to convert to an ETMF structure. Those will illiquid assets, such as those comprised of PE (private equity), property or debt assets. “You can’t give people liquidity if there isn’t any", Wilson says.

“But for an equity, a long-short, or a standard LIC that holds liquid assets, it’s definitely viable.”

For investors, the advantage of such shifts means they can move from an investment vehicle that, in most cases, has been consistently trading at a discount to one that always trades at its net asset value.

“Generally speaking, if you’re going to make a one-off gain from getting rid of the discount, I’m sure most people are okay with that,” Wilson says.

What makes a good (or bad) LIC?

The attributes Wilson emphasises are:

• Performance, “which will sink or swim a LIC”
• A loyal shareholder base - the longer shareholders are there, the more stable the shareholder base
• History of distributions or dividends
• Regular marketing to investors
• Costs

Wilson notes that the higher fees of listed investment companies, particularly compared to ETFs, is a long-running issue for the sector. And while he concedes additional costs are involved in running a LIC, including director fees and listing fees, he believes criticism of costs is often justified.

“The reality is that most LICs charge too much in fees and costs for the investment performance they deliver,” Wilson says.

LICs are more expensive than managed funds, but the comparison with ETMFs is more difficult because the involvement of market makers adds to the cost structure – particularly for smaller ETMFs.

What’s next?

The appearance of new LICs on the ASX is a rare occurrence these days, with the WAM Strategic Value (ASX: WAR) that IPO’d in 2021 among the few to list in recent years.

Wilson believes the lack of new LICs is partly because the minimum size of LICs is now far higher than it used to be.

“There have been some that have taken existing funds and listed it, such as H&G High Conviction (ASX: HCF), but there have been few others,” Wilson says.

“And if LICs are trading at a 15% to 20% discount, it’s a pretty tough environment in which to stack up a new LIC.”

Wilson suggests these discounts to NAV need to improve by 10% to 12% before we see new LICs coming to market, “if indeed we will see this in any volume again.”

That said, Wilson believes the LIC structure will survive, noting that there are also “healthy markets” of LICs in the UK, US and Canada (where they’re simply called closed-end funds).

He notes that ETMFs have become more sophisticated and are now more of an option, but the grey area remains for those managers investing in Alternatives such as long-short, property or other illiquid assets.

“The ETMF isn’t for everyone because of that liquidity and market-making requirement…that’s why there are still healthy markets in other places,” Wilson says.

The LICs Affluence is watching

In addition to Magellan, he believes Platinum’s LICs, Platinum Capital Limited (ASX: PMC) and Platinum Asia Investments Limited (ASX: PAI), are under pressure.

“Because when Magellan does something, Platinum has to follow, and they’re both trading at discounts of more than 15%,” Wilson says.

Wilson also notes that VGI Partners Global (ASX: VG1), owned by Regal Partners since June 2022, has seen activist investor Saba Capital take substantial holdings. He believes Regal Asian Investments (ASX: RG8) – a sister LIC to VG1 – may have more of a grace period, "but will come under pressure if VG1 leaves the LIC space".

“Saba also has a substantial stake in Pengana International Equities (ASX: PIA) and will no doubt be pushing for change, because that one, in particular, hasn’t performed well. So, watch this space," Wilson says.