Market corrections are meant to be a prime opportunity for active managers to shine. However SPIVA research shows that even after going through one of the steepest market corrections in history, most active fund managers have underperformed their benchmarks so far in 2020.
LIC performance disappointing over five years to 2020
As a follow up to our piece on LIC performance in 2019, we’ve reviewed the performance of Australia’s listed investment companies (LICs) to see how they handled the COVID-19 correction, and assessed their performance for the period ending 30 June 2020.
LICs have the benefit of being able to smooth out dividend payments and reserve income during turbulent times, but our findings show poor total returns.
Over the last five years to 30 June 2020, ~80% of Australian share LICs failed to outperform the market tracking index ETF. Global share LICs fared even worse, with 82% failing to outperform the global 100 ETF.
Investors in LICs would have been better off by $3.4 billion over the last five years if they had simply invested into an equivalent index-tracking ETF.
If you had invested $10,000 in one of Australia’s largest and most popular LICs five years ago it would be worth roughly $12,000 today including dividends and capital growth. That same amount invested in the Vanguard Australian Shares Index ETF (VAS) would have double the return at ~$14,000.
LIC growth slows dramatically in 2020
LIC growth has slowed dramatically in 2020, with poor performance being a major contributing factor. LICs only grew assets by 4% over the year to 30 June 2020, compared to ETFs which grew assets by 43%.
After overtaking LICs in 2018, ETFs have continued to widen the gap on assets under management as more investors seek ETFs due to their lower cost, tax efficiency, better performance and transparency.
Additionally, the government banned commissions (called stamping fees) on LICs in May 2020. Stockspot’s research featured in ASIC’s recommendation to the Treasurer. This has leveled the playing field for investors.
The ban on LIC commissions is another factor slowing down the growth of LICs, and some LICs are now looking to convert to an open ended structure like an ETF.
The big winners out of this are investors who have gravitated to ETFs with lower fees, superior performance and more certainty of market returns.
LICs charge higher fees
Fees is one of the biggest decorators of performance. LIC fees are double what typical index ETFs charge, with the average LIC costing 0.98% per year, whereas the average ETF costs 0.50% per year. (note: weighted average 0.71% vs 0.33%).
The impact of high costs becomes more apparent with each passing year as LICs find it more and more difficult to generate sufficient returns to make up for the drag of their costs.
LICs and discounts to NTAs (net tangible assets)
One of the biggest drawbacks with LICs is their tendency to depart materially from the underlying value of the assets they hold – known as the net tangible asset (NTA). The average discount to NTA (both pre and post tax) for LICs is currently ~10% (source: ASX).
This wide discount to NTA that LICs face is likely to be an irreversible cost of permanent capital – investors don’t like that they only take money out of LICs by selling to another investor. A seller of an unwanted LIC may have trouble finding buyers and this lead to many LICs trading at permanent discounts.
The sharp discount to NTA also partially reflects the present value of fees that investors will pay since they have no confidence in the LIC manager outperforming its benchmark in the future.
While the price of an LIC can make it seem like an ‘undervalued’ investment (investors can buy $1 for 90c) but this reasoning falls over when persistent historical discounts are taken into account.
Similar to 2019, LICs continue to have once again underperform their benchmarks and equivalent ETFs in 2020. Structural changes to stamping commissions, and their slow growth in the years to 2020 have contributed to their disappointing performance, but there is still $45 billion trapped inside LICs.
We expect a substantial amount of this money will move from LICs to ETFs as investors recognise the benefits of this alternate investment strategy.