Does Size Matter for Listed Investment Companies?

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With some merger and acquisition activity starting to happen in the Listed Investment Company (LIC) space recently ‒ investors may be wondering if size matters with LICs. Well, it does and it doesn’t.

There are around 100 or so LICs currently listed on the Australian Securities Exchange (ASX). The volume of LICs grew significantly in recent years following the introduction of, and subsequent amendments to, financial planning regulations known as FoFA (Future of Financial Advice) and the significant growth in the self-managed super fund sector. The introduction of FoFA, which in part banned sales commissions, has led to a number of fund managers looking to the listed market to grow their funds.

The number of LICs on the ASX is now consolidating, which has naturally put a spotlight on the question of what impact the size of a LIC has on its performance and longevity.

Many of the LICs that have come to market over the last 10 years are small or do not appear to have focused enough on shareholder engagement. They have ended up with their share price trading at large discounts to their net tangible assets per share (NTA). NTA is the value of the total portfolio divided by the number of shares in issue.

The LICs have tried numerous ways to close that discount, but it’s been difficult for some of them. Obviously, performance is an important factor, but taking this out of the equation, both AFIC’s observation and industry research suggest that the extent of discounts to NTA are partly related to the size of the fund.

Recent research by Independent Investment Research (IIR) says there appears to be a strong link between size and discount: the larger the LIC, the lower the discount no matter what area the fund is invested in. According to IIR, larger LICs generally follow diversified strategies, and typically provide greater liquidity. Smaller LICs often employ more specific strategies, generally with greater risk and therefore specific returns depending on the strategy of the fund. This feature, along with limited size, can often produce an ongoing discount of the share price to the NTA.

IIR noted, however, that investor confidence in the fund manager is a key mitigating factor in the discount-to-size relationship, to the extent that LICs with a good fund manager can trade at significant premiums to NTA irrespective of their size.

AFIC believes that bigger market size for a LIC – perhaps close to $500 million – provides investors with sufficient liquidity in the LIC’s shares on the ASX. If a fund has more liquidity in the market, it provides a more seamless process for investors to buy or sell the shares, a greater profile and favourable ‘word of mouth’ recommendations among a large number of shareholders.

A bigger size also enables the LIC to dedicate significant resources to shareholder engagement and marketing activity that is sometimes not possible in a smaller fund.

Smaller funds also can be expensive to run, while larger funds, which have economies of scale, can offer good value. This gives a bigger fund such as AFIC a better chance of trading closer to NTA or at a premium. In a traditional LIC such as AFIC, the benefits of scale flow back to shareholders.

But as mentioned earlier, this is all prefaced by performance. Performance is the key determinant. If a fund does not perform, it doesn’t matter what size it is.

AFIC has continued to attract investors because of its model of internal management, which produces a low management expense ratio and consistency of returns, including dividends and lower volatility than the market.

Consolidation in any market is likely to occur where there are many competitors, and where the share price does not reflect the value of the NTA or even the performance of the fund. We’re seeing that on the Australian market now with the likes of Washington H. Soul Pattinson’s proposed merger with ASX-listed Milton Corp, and WAM Global’s proposed merger with Templeton Global Growth. You might call it natural evolution.

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