A ban on stamping fees could stunt the growth of the listed investment companies sector, while exchange-traded products could be the biggest beneficiary, as the sector experiences a quick rebound from the March sell-off.

While commission payments on most investment products including unlisted managed funds and ETPs have been banned since 2012, LICs and listed investment trusts were exempted by the federal government in 2014. That recently changed and stamping fees have now been outlawed for LICs, and the sector’s growth has since then lagged that of ETPs.

As at 31 July 2020, the LIC sector, which includes listed investment trusts, had a total market capitalisation of about $45.37 billion across around 111 listed products, up from $40.46 billion since March 31, or 12 per cent. But the market cap remains down from a market cap of $53.49 billion in January 2020, representing a fall of about 18 per cent, and down from 114 products listed.

In contrast, the market capitalisation of the ETP sector had climbed to $66.90 billion as at 31 July 2020, up slightly from $65.70 billion in January, and well up from $56.63 billion as at 31 March, rebounding 18 per cent after the covid-19 induced sell-off. The number of products listed was steady at 211. Exchange-traded funds make up around 90 per cent of the ETP industry.

Levelling the playing field

Federal Treasurer Josh Frydenberg has said extending the ban on conflicted remuneration to LICs will address risks associated with the potential mis-selling of these products to consumers and improve “competitive neutrality” in the funds management industry. Analysts predict the ban will promote ETPs at the expense of the LIC sector.

“I think that the ban on stamping fees has made a more level playing field between ETFs and LICs,” says Ross MacMillan, senior analyst, manager research at Morningstar.

“I think it is likely that we will see fewer LICs going forward, but ETPs will continue to grow at a high rate, both passive and actively managed funds, as more and more investors move into ETPs rather than LICs.

“LICs are more traditional investment vehicles and some have been around for 60 or 70 years, such as Milton or BKI Investment Company. They hold more traditional investments in the large ASX 200 companies, such as the big banks and the big miners.”

In contrast, ETPs have a newer structure and tend to be more actively managed and exposed to growth stocks, MacMillan says.

“This is more attractive to investors who are attracted to technology stocks like Afterpay and fintech and biotech stocks. Investors are chasing these sectors, which don't often feature in LICs’ holdings, but are more often held by ETPs.

“Over the past six months we've seen a much younger demographic becoming interested in ETPs given the greater accessibility of these technology and fintech stocks, which has helped to drive the market growth.”

ETPs are also more accessible. Some like Airlie Australian Share Fund can be traded on the ASX or via an unlisted managed fund. “So, the ETP structure is more innovative, which is attractive to investors. Even if you bought into the Airlie Australian Share Fund via the unlisted vehicle, you can sell your units on the ASX,” says MacMillan.

However, he also points to the benefits of LICs, which often pay steady dividends, particularly if they invest in Australian equities or even global equities. That will keep retirement investors in LICs, even if their number diminishes overall.

“I think that the traditional LICs will survive, the larger funds like Milton and BKI Investment Company, as they will continue to appeal to investors seeking income,” MacMillan says.

Fees may curb new LICs

Jarad Stirling, principal of Stirling Financial Consultants, has recommended LICs and ETF to clients for several years. As a member of the Certainty Advice Group, Stirling’s revenue model has never included stamping.

“Stamping fees have never been part of our remuneration model so their removal won’t change our process. It may reduce the number of new LICs coming to market and attracting funds under management,” says Stirling. 

“We believe there is room for EFTs and LICs in a diversified portfolio.  One benefit of the so-called old school LICs over ETFs is the company structure and ability to retain earnings which helps smooth dividends overtime and is easier to for tax planning.

“For our clients, we prefer the old-style LICs with low management fees, low turnover, simple and easy to understand mission statements which are generally around growing a tax effective income stream for shareholders.

“Companies like Argo, Milton, Australian Foundation Investment Company and Mirrabooka have been around longer than most fund managers and ETF providers will continue to thrive regardless of stamping as the interests of these companies tend to align with their shareholders,” says Stirling.  

But whether investors buy LICs or ETPs, they must be vigilant about net asset values (NAVs) and make sure not to buy at a big premium or sell at a big discount to the NAV, says Morningstar’s MacMillan.

“Retail investors need to be careful about the NAV and if there is enough liquidity in the LIC or ETF. It is vital for both ETPs and LIC investors to be able to get out of the investment when you need to, particularly in times of volatility.”

Visit Morningstar's Reporting Season 2020 coverage. The calendar will be updated daily to connect you with our equity analysts' take on the financial results.

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