An ASIC analysis used to make a case against conflicted selling arrangement such as so-called stamping fees associated with LICs and LITs doesn’t present a full picture of the investment structure, according to an independent investment consultant’s analysis.
In particular, like-for-like comparisons of after-tax returns, proper consideration of the value of options associated with these listed products, as well as representation of an LIC/LIT performance time horizon and the potential value of reinvested dividends are all shortcomings which threaten to undermine the regulator’s recommendations to government in this area, Dominic McCormick reckons. McCormick was an expert panelist on the topic at Professional Planner’s recent Researcher Forum in December.
“Proper returns analysis of LICs/LITs is more complex and nuanced than many perceive and needs to be multi-dimensional.” McCormick says. “A range of mistakes can easily be made and ASIC’s recent analysis… has made most of them.”
“Simple analysis of share price plus raw dividend returns… is obviously relevant to investors, but is far from the full picture,” he adds.
ASIC’s analysis of 48 LICs/LITs listed between 2015 and 30 June 2019 was revealed following a freedom of information (FOI) request as part of the ongoing coverage on the topic by the Australian Financial Review. The ASIC analysis and correspondence regarding the analysis has since been viewed by Professional Planner.
Mainstream press coverage of stamping fees in recent months argues that these incentives represent a workaround for fund managers seeking to remunerate advisers and brokers to sell their products, incentives banned under Future of Financial Advice (FoFA) reforms for unlisted products.
McCormick’s counter-analysis suggests the topic could be more complex than this coverage suggests and indeed is likely to be addressed as part of the FASEA’s new Code of Ethics which advisers must adhere to starting as of January this year.
“Shouldn’t we allow client best interests duty and commitment to ethical behaviour drive decisions around whether advisers/brokers receive some or all these stamping fees, or instead rebate them to clients, particularly with most stamping fees in the 1-1.5 per cent range?” McCormick asks.
ASIC was contacted but declined to comment for this article.
McCormick’s view that stamping fees will be addressed by best interest rule is supported by high profile listed investment company provider and founder of Wilson Asset Management, Geoff Wilson, who tells Professional Planner he believes these incentives don’t impact outcomes for investors. Wilson was a prominent voice in the campaign against the Labor government’s plan to abolish tax refunds for franked dividend recipients which it took to the last federal election.
“The performance of the underlying manager, the tax paid and the fully franked dividends paid to the investor determines the outcome for investors,” Wilson says.
The initial carve out for stamping fees was given because of an argument that companies would not be able to raise capital, ASIC observed. While LICs were left out of this original carve-out, it was the Abbott government which decided to extend the exemption to these structures.
“If an investor was paying an annual advice fee to a financial planner or wealth manager and they recommended a LIC/LIT IPO, client best interest would suggest that any stamping fee should be fully or largely rebated to the client,” McCormick states. “But could a stockbroker whose business relies largely or exclusively on transaction fees and other financial services groups that are making the fund available directly to clients be justified in receiving a small stamping fee for the work involved in orchestrating the concentrated nature of these closed-end, listed offerings?” McCormick states.
As part of his counter-analysis, which was also published on Livewire this week, McCormick highlights the following points:
- Share price plus dividend return is driven not just by underlying NTA return but by the starting and ending price relative to NTA (i.e. discounts/premiums) and is very sensitive to ending discounts. Neglecting these dynamics and looking at investor experience at one point to point time period can result in a misleading judgement on longer term investment performance.
- Because of tax paid and payable, a larger part of a LIC’s return is typically franked dividends so a simple comparison with unlisted funds/ETFs without considering the different taxation arrangements is inappropriate and can understate LICs returns. LICs also usually have franking credit balances reflecting previous tax paid that can benefit investors in the future. This contrasts to unlisted funds that typically have a large unrealised, but largely hidden, capital gains tax liability which will eventually be distributed and taxed in investors hands, lowering after tax returns.
- Some of the LICs/LITs listed since 2015 involved an initial issue price at a premium to NTA of 3-4 per cent because investors paid all the costs of the issue. Investors in LICs/LITs started with this additional drag on performance compared to an unlisted fund or ETF. More recently, managers of LICs/LITs have met this cost, a significant and welcome improvement on prior LIC/LIT investor experience, and this has become the standard model of LIC/LIT capital raising today meaning investors now typically don’t pay any initial costs, including stamping fees, and have the benefit of a starting NTA equal to the issue price.
- In the case of around half of the 48 funds listed since 2015 in the ASIC analysis there were listed options attached as part of the IPO. ASIC in its analysis has ascribed no value to the ability of investors to realise value by selling these options on market or in exercising those options that were “in the money” on or before expiry. Importantly, in cases where options were in the money and exercised, those investors received a return benefit by being able to purchase at a price below market, although NTA would have suffered dilution from these option exercises, which would drag down performance as measured by the share price alone.
- In many cases advisers rebate part or all the stamping fees to investors so the effective return since inception has been higher by the amount of this fee rebate. (Stamping fees are typically 1-2 per cent, not the much higher levels some media commentators have been quoting). It is difficult to determine the amount of rebating that goes on but it seems to be significant amongst financial planners and is likely to increase under stronger enforcement of the investor best interest duty and the FASEA Code of Ethics that came into effect from 1 January 2020.
- ASIC analysis of 48 funds simply looks at raw absolute performance and not against their own relevant benchmark. Many of the LIC/LIT funds that have listed since 2015 adopt specialist investment strategies including long/short, market neutral and income focused. These strategies generally aim to have a lower risk profile than equity markets, would be expected to lag in a strong share market and should not be naively compared to equity markets or equity ETFs.