Part 2: A guide to Listed Investment Companies

In part 1 of the guide to listed investment companies, I went over the key structures that make up an LIC.

That’s all the boring stuff, but kind of important to know so you understand what you’re getting yourself into. Because as they say, when shit hits the fan you need to believe what your invested in works over the long term to ride out the volatility.

In this next part, I’ll go over the fun stuff. The benefits of investing in LIC’s and some of the risks.

Risks

Let’s get this out of the way first.

Investing in the stock market isn’t as risky as you might think. If you’ve read my post on what’re shares, you’ll know that when you buy a share of a stock, you’re becoming a part owner of the business. No different to being a part owner in the restaurant up the road.

I say this again because it’s an understanding of the market that’s vital to learn, it helps to ride out the market volatility that gets mistaken for risk.

Most newer investors (I know I was this way) get spooked by volatility and jump out at the worst possible time. As their portfolios decline they sell in fear, locking in the loss that otherwise would have bounced back. So here are some of the risks that you need to know.

Market risk

You know when you jump onto social media and you hear billions have been wiped off the market?

That’s market risk, they’re referring to the entire stock market declining. Not the losses of individual stocks.

If the whole stock market goes down, your LIC is exposed to this and will most likely sell off too. Most of the older LICs are passive in nature and hold the same stocks similar to the index.

So, the index sells off, the LIC’s won’t be far behind.

Lots of squiggly lines. The green and red bars are the asx300 index price chart and the blue line is Argo. Notice how Argo moves similar to the index.

But there is nothing wrong with the sell off, markets don’t go straight up. If the market sells off while you’re involved in a LIC, but you believe in the strategy you will be more likely to ride out the volatility and buy more at lower prices.

Remember some of these older LIC’s have been around since 1920, a century old. That’s a long time. They have been through depressions, recessions, world wars & cold wars. But still around to benefit long term investors.

Stay the course.

Fund Manager risk

The fund manager, manages the portfolio and decides which way he wants to invest.

An old manager that’s performed really well might leave and a new one comes on that isn’t as good, giving lower returns. This style of management is more for an LIC that’s active in buying and selling stocks.

In my opinion the older LICs are stuck in their ways, harvesting dividend income and returning them to shareholders.

But there’s still a chance a new fund manager comes along and persuades the board to start investing in a new way. Which could result in better or worse returns.

Alright, so risks out of the way what benefits can we expect?

Dividends

Most Listed Investment Companies have their mission to provide fully franked rising dividends over time. In my opinion it’s the older LIC’s that try stick to this mission statement the most.

In the early 1900’s and throughout history, dividends are what investors were after. With investors backing these companies on public markets, they wanted to be rewarded for money they’d put into the company.

The older LIC’s have heritage, and obviously want to keep that tradition. I could be completely wrong but that’s what I’ve put it down to.

Straight off Milton Corporations website.

If you’re goal is financial independence, then a rising stream of dividends is what you’re after.

Your assets are spitting out enough cash flow to cover your expenses. As long as the share price isn’t going down over a long period of time then it’s all good, your money will just slowly compound with dividends and the stock price growth.

Argo’s beautiful dividend growth since 1986.

The older LIC’s that I keep talking about, they usually just harvest the dividend income and pass it back to shareholders. And, every now and then you’ll receive a special dividend when they’ve sold off some shares and realized a capital gain.

Side Note: Fully Franked Dividends

The crown jewel for Australian dividends. The franking credit system!

We’re the only country in the world that has this system (as far as I know). And it’s the envy of the international dividend community.

Franking credits are a little complex and take time to get your head around, so I’ll keep this part short with a quick explanation.

Companies pay dividends to shareholders out of their profits, companies pay 30% tax on those profits. To avoid the profits being taxed twice, you will get a franking credit attached to your dividend.

This franking credit is the tax the company has already paid for you. And it makes sense, really.

If a company has paid tax on those profits why should you have to pay tax on the same money that’s already had tax applied to it.

That’s about as much detail as I’m willing to go into at the moment. Franking credits deserve an entire post on how they work. In my experience you need to go through lodging a tax return while owning shares that pay a fully franked dividend to get the best understanding of how they work.

If you want to dive into franking credits follow the link https://www.frankingcredits.com.au/

Returns

What type of returns can you expect?

That’s going to vary from each LIC, but all the older LIC’s are ballpark similar. And, because they shadow the index the returns will be similar to the index.

This LIC is giving you the NTA return (remember NTA?) and it’s share price return plus dividends. A lot to take in, you’re probably wondering how that all makes sense.

Not to worry, they do it all for you. When doing the research and you come across the returns you’ll want to be able to read what they’re saying.

All funds give their returns over a period of time. And, they’re meaning over that period we’ve averaged this return each year.

The 20-year share price bar is saying, if you had been invested with us over the past 20 years you would have had a return of 8.8% each year. On average.

One more for Milton Corporation.

Over a 20-year period the average return was 8.85% a year. I’m only using the 20-year period as an example; you can pick any of those time periods and it reads the same.

What the numbers mean

Continuing with the 20-year example, it’s saying on average your money would have grown by 8.85% a year. Similarly if you were reading the row for 15 years on average it would have grown by 6.18% a year.

All funds that show their returns over a period of time read the same way, it’s the results they’ve produced during that time period measured.

You may have noticed from the sentences above I said on average.

This means you’re not guaranteed 8.8% each year. The share price might rise 10% one year and fall 5% the next year. Giving you an average of 7.5% for the two years. It’s just the average over each time period.

Over the 20 years, with dividends being paid and the share price rising and falling (but consistently going up over time) it produced on average an 8.85% return each year.

You also want to look at shareholder returns, or share price returns. You’ll receive whatever the share price does not the underlying portfolio of the fund. The share price performance is correlated to the portfolio performance but you’ll receive whatever the share price produces, plus dividends.

In Miltons example above, the row that says MLT TSR is the acronym for Milton Total Shareholder Returns.

The TSR represents the share price appreciation plus dividends. This is the return you would have received, not the portfolio return.

One more note. When you see the quote total returns, this means the share price growth plus dividends paid. So, if the share price rose 4% on average and there was 4% in dividends paid, then the total return is 8%.

Who are these older LIC’s you keep talking about?

The below are 6 well known gran daddy LIC’s.

Australian Foundation Investment Company (ASX: AFI), Argo Investments (ASX: ARG), Australian United Investment (ASX: AUI), Carlton Investments (ASX: CIN), Milton Corporation (ASX: MLT), Whitefield (ASX: WHF)

It’s up to you to do further research and see if any of these LICs suit your style or your investment goals. These LIC’s have long operating histories, which for me is a sign of staying power and being able to invest in good and bad times.

The final wrap up

There’s plenty of information here, and I’ sure I’ve missed something. However, part 1 used with part 2 is enough information needed to invest in LIC’s for the long-term passive investor. You should still do some research to see if it’s the right fit for you. Doing the research will also make you a better informed investor and help you make better decisions.

Tell me what you think below if I missed anything.

Disclaimer: Please don’t go out and buy all 6 of those LIC’s or any stock for that matter. This post is for your education and enjoyment only, please do your research or talk to an investment professional before investing any money.

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