Listed investment companies yield to market

Australia’s listed investment companies have been “out of favour” for more than a year, ever since new capital gains tax rules were announced, but for many investors it may be timely to reconsider this sector.

The main listed investment companies (LICs) include Australian Foundation Investment Company, Argo Investments, Milton Corporation and Australian United Investments.

These companies have a long and successful track record of managing diversified blue chip share portfolios. AFIC holds shares in about 120 Australian companies worth $2.2 billion, while Argo holds about 200 stocks worth $1.2 billion.

The LICs provide an alternative to investing in unlisted unit trusts managed by the likes of MLC, Perpetual and Colonial First State.

However there are some critical differences between the two sectors.

The most pertinent is that new capital gains tax rules – which halve the capital gains tax payable on assets held for more than 12 months - will not be extended to LICs.

They do not qualify for the status of collective investment vehicles and therefore they will not receive the concessional capital gains treatment.

Since the tax changes were announced in late 2000, the share price of all LICs has weakened.

Traditionally they traded in line with, or at a premium to their net asset backing (i.e. the amount of money left after selling all of their assets and repaying all debts).

Now they trade at a discount of 10 to 15 per cent.

AFIC and Argo have launched share buy-backs, which have boosted their share price, but they are still well below net asset backing.

AFIC Chairman Bruce Teele believes the market’s reaction has been rather extreme, blaming fear of the unknown.

“AFIC does not set out to realise capital gains and consequently its capital gains tax history has been far too small to justify anything like the share price reaction that has occurred”, he said.

If the new tax rules had applied over the last five years, AFIC estimates that investors would have earned an extra one third of one cent by holding the investments directly or through a unit trust.

This would be outweighed by the higher management fee on most unit trusts, which equate to about 2.5 cents a share for AFIC.

Looking at this another way, the management expense ratio of AFIC and Argo is less than 0.2 per cent per year, well below the 1-2 per cent ratio for most unit trusts.

“In addition, when AFIC does sell shares from its long-term portfolio it is generally the result of takeovers. In future any takeovers that involve settlement in the shares of the acquirer will result in postponing any capital gains tax until such shares are ultimately sold,” Mr Teele said.

Another key difference between the two sectors is that LICs have the ability to retain reserves, whereas unit trusts must distribute nearly all profits and capital gains to investors in the year in which they are received.

This means that LICs have the capacity to smooth dividend payments to their shareholders.


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