Listed investment companies have suffered the fallout of government policy changes, with the sector anxiously awaiting the federal treasurer’s review of “stamping fees” paid to brokers.

As the debate rages, what does the future hold for the $48 billion sector and do LICs still have a place in investors’ portfolios?

In July 2019, federal Treasurer Josh Frydenberg put the sector on notice, saying that he had asked both the Australian Securities and Investments Commission and federal Treasury to advise on “the extent to which inappropriate advice is being provided in relation to LICs”.

This followed increased scrutiny in the wake of the Hayne royal commission, which prompted a review into commissions paid by LICs to stockbrokers for promoting initial public offerings. Such commissions, known as stamping fees, are usually around 1.5 per cent and paid for placing retail investors into these IPOs – which sparked accusations that such investors might be pushed into inappropriate products.

Hayne called for all rules affecting financial advisers, including exemptions to “conflicted remuneration” to be reviewed by 2022. Commission payments on other investment products have been banned since 2012 under the Future of Financial Advice laws. But LICs and listed investment trusts were awarded an exemption by the federal government in 2014.

Unlisted managed funds and exchange-traded funds remain banned from paying stamping fees.

As at 29 February 2020, the LIC sector had a total market capitalisation of around $48.4 billion across around 110 companies. This spans a broad range of asset classes including Australian and international shares, private equity, property and fixed income, according to Morningstar data.

Retail risks

Critics such as Australian Financial Review columnist Christopher Joye have argued that the stamping fee exemption has caused a surge in retail investment into the LIC sector, which has doubled in size over the past five years.

With some $440 million paid in fees to advisers in the past three years, Joye argues that advisers have promoted hedge fund, junk bonds and other LICs with a “complex array of risks that few retail investors could hope to understand”.

“Ipso facto, the fees unambiguously motivate advisers to funnel client funds into complex products when it is rarely in their clients’ best interests to do so,” he said in his 31 January column.

This “competitive dysfunction” is also affecting the advice industry, with conflicted advisers who take sales commissions from fund managers able to discount their fees to clients.

“Over time, conflicted advisers will capture more and more market share as unconflicted advisers cannot compete with their lower fees. The casualty will be the quality of advice Australians receive,” Joye claims.

Recent ASIC analysis found that of 48 LICs and LITs that had floated on the stock exchange since 2015. Of these, a “significant proportion” had negative returns, with a cumulative return of negative 6.1 per cent since inception – although this analysis has been disputed by the industry.

LICs issuers press pause

On 27 January, the federal government announced that Treasury would undertake a “four-week targeted public consultation process on the merits of the current stamping fee exemption in relation to listed investment entities”.

“Public consultation will allow the government to make an informed decision on whether to retain, remove or modify the stamping fee exemption in order to ensure that the interests of investors are protected and capital markets remain efficient and globally competitive,” the statement said.

Yet after completing the consultation period on 20 February, receiving around 40 submissions, the government has yet to announce its decision.

The uncertainty has seen a pause in the launch of new LICs, including PIMCO’s planned $1 billion Australian corporate bond fund IPO, which it blamed on “market noise” concerning Frydenberg’s announcement. Other international managers including CVC Credit Partners have also shelved IPO plans.

Yet others are taking a different approach. Last August, the launch of the Magellan High Conviction Trust LIT (ASX:MHH) saw the global equities fund manager become the first in Australia to eliminate payments to stockbrokers and financial advisers.

Meanwhile, LICs have also come under scrutiny over performance, with many trading at a discount to their net tangible asset backing. Another issue is the lack of liquidity in some of the smaller LICs, making it difficult for investors with large positions to exit.

However, fund manager Geoff Wilson has argued that LICs are superior to “opaque” managed funds, which can disguise tax liabilities. A removal of stamping fees could restrict competition by limiting the number of new entrants, and other analysts also warn against discouraging global bond managers from the ASX.

'It wouldn't kill the market'

Ross MacMillan, senior analyst, manager research at Morningstar also points to some other benefits of LICs.

“There’s a level of transparency being on the stock exchange, as they have to hold an annual general meeting, put out half-year accounts that have to be audited. If investors aren’t happy they can vote out the board of directors,” he says.

“Also, a lot of LICs pay steady dividends, particularly if they invest in Australian equities or even global equities."

Regarding the potential effect of a ban on stamping fees, MacMillan says: “It wouldn’t kill the market, but it would mean that we’d tend to see a lot more of the larger, well-established funds being able to come to market and fewer of the smaller boutiques. They might stick to being unlisted”.

And this amid a sector already facing pressures from the COVID-19 pandemic. The upcoming US presidential election could further cap the number of IPOs this year, says MacMillan.

LICs favoured by Morningstar include Platinum Capital Limited (ASX:PMC), awarded a silver rating in March 2019 for offering “a convenient access point to an excellent global-equity strategy."

The Magellan Global Trust (ASX:MGG) also earned a silver rating in February 2019 for its being “a highly rated investment process, predictable distribution profile, and convenient exchange traded access”.

Can LICs ride out uncertainty?

MacMillan suggests it ultimately comes down to performance, since “the investment manager has to achieve outperformance in its asset class, which will attract investors”.

Looking ahead though, the investment vehicle is still seen maintaining a presence on the ASX.

“Historically, there are LICs that have been around for 70 odd years…I think we’ll continue to see these sorts of LICs and a lot of the newer ones for at least the next 40 to 50 years,” MacMillan says.