Means of control

By PHILIP MACALISTER

Investing and saving money may appear to be all about numbers, but they're often about fashion as well. And, like clothing fashions, investment fashions go in cycles.

The latest item to be back in vogue is the listed investment company - a form of managed investment with a style of its own.

In recent months there has been a plethora of new offerings of listed investment companies in Australia. Some of those funds, such as Peters Macgregor Investments, are also being promoted in New Zealand. And we have our own offering in the form of the Kingfish fund.

Once these funds get off the catwalk and on to the streets, they will join other listed investment companies already on the stock exchange.

But what is a listed investment company (LIC) and why is an outfit like Fisher Funds Management - known for its unit trusts - involved in this area?

First, LICs are nothing new. They've been around for decades, with more than 100 now listed on the Australian Stock Exchange. Many Britain-based LICs can also be bought and sold on the New Zealand Exchange and are widely used by investors.

In the past they have been described as the best-kept investment secret in New Zealand, but right now listed investment companies are the in thing.

What are they? Just another way of allowing people to pool their money and obtain the expertise of professional money managers.

But there are differences between LICs and other types of managed funds, such as their structure, their fees, how they are bought and sold, and how the price is set.

In structure, LICs are "closed-ended" while unit trusts are "open-ended".

A closed-ended fund raises a set amount of money from the public, then doesn't ask for any more. The only way that money can grow is by being invested and earning returns which are added to the original sum (minus expenses and the manager's fees).

With an open-ended fund, the manager is always trying to grow the amount under their control. As well, the manager has to look after the number of units on issue, redeeming them from people who want out and issuing new ones to investors coming in.

Fisher Funds chief executive Carmel Fisher says this is one of the great beauties of the LIC - as a manager she doesn't have to do anything about looking after the units on issue. "It's nirvana for a fund manager to have a closed-ended vehicle."

Money can be raised and invested over the long term without issues such as having to make sure there's enough money on hand to redeem units from investors who want to pull out. That is especially useful when investing in smaller and illiquid companies. "We can truly act like long-term investors," she says.

From this angle LICs are far more efficient to run and give the manager some certainty.

The other major difference, and an area where there is some argument about LICs, is that the market sets the price. With other types of managed fund, the price is set regularly - based on the value of the fund's investments, divided by the number of units on issue.

The price that is calculated and published is what everyone in the fund would get if it was closed that day and the assets sold at the prevailing market price.

But with a listed investment company the price is set by that hard-to-catch character, Mr Market.

Mr Market bases his price not just on the asset value, but also on sentiment. That price can be more than shares in the company are theoretically worth - that's called trading at a premium - or it can be less, known as trading at a discount.

If you buy into an LIC at a premium you are paying more than the value of the assets of the fund on that day. A discount, on the other hand, looks like a good deal - you get assets at below their market price.

What scares many people off LICs is that they often trade at a discount. While it seems like good value buying assets for less than their market price, it's only a good deal if the discount narrows or, even better, turns into a premium.

But the logic behind discounts and premiums is hard to understand. British LICs have generally traded at a discount for years and these discounts had widened - not narrowed - until recent times. In Australia, the market price has historically varied significantly, from 20 per cent discounts to premiums of more than 30 per cent.

Many of the new LICs are trading at a premium, even though they are new and, as Fisher points out, nothing but cashboxes because they haven't invested all their money. Others such as Kerr Nielson's Platinum fund has been trading at massive premiums - around 40 per cent - for several years.

This raises an interesting conundrum as Platinum runs two versions of the fund: one listed and one unlisted.

People in the listed version can sell their holding at a huge premium and then buy the same assets in the unlisted fund at par.

From an investor's viewpoint the whole issue of discounts and premiums is best summed up as one of the risks they face when they consider these types of investments over an unlisted managed fund.

Another important difference between LICs and other managed funds is that the companies generally - but not always - have an independent board which contracts out the job of managing the investments.

With a managed fund, unitholders have very little influence on who actually does the managing.

Fisher says the Kingfish structure allows the board to sack the manager for reasons such as poor performance.

And it does happen. There have been examples, such as the New Zealand Investment Trust, where changes have been made to who is involved in looking after the money.

Likewise, listed investment companies have opportunities to use "financial engineering" tools to improve their returns. The two main tools on their workbench are the use of debt and the ability to buy back their own shares.

It is not unusual for an LIC to acquire its own shares when the board considers that their price does not reflect the underlying value.

Supporters of listed investment companies also like to point out that they are cheaper than managed funds and there is greater transparency in the way they operate, especially since they come under stock exchange rules. Many of these listed vehicles also have performance-based fees - not widely used in the managed funds arena.

In fact, one of the reasons underpinning the growth of listed investment companies in Australia is that people who use managed funds have been disappointed with performance over the past three years and feel the funds are too expensive.

They see the listed approach as a better option.

Fisher's explanation of why the Kingfish fund was spawned gives a good idea of where LICs fit into the market.

She says there are many investors who would like to get access to things like Fisher Funds Management's investment skills and style, but they would never go near a managed fund because they don't like the structure - for whatever reason.

But because an LIC is a share which is traded on the exchange, and its fees are generally lower, it becomes an alternative with which they are comfortable.

* Philip Macalister is the editor of the online personal finance magazine Good Returns.

* Email Philip Macalister