Listed Investment Trusts – Where’s the conflict?
I was recently asked by a client about several articles in the press on Listed Investment Companies (LIC’s) and Listed Investment Trusts (LIT’s).
These articles appear to be prompted by the recently announced raising of yet another listed investment vehicle by Magellan Financial Group, to be called the Magellan High Conviction Trust. This raising will offer no placement fees for advisers and stockbrokers.
Spurred on by Magellan’s bold pricing move, the focus of these articles appears to be outrage that placement fees (typically in the order of 1% but paying anything up to 4%) are paid at all on other LICs and LITs.
The authors work themselves into a lather of indignation at the prospect of such offers using a loophole to bypass FOFA (Future of Financial Advice) conflicted revenue laws. The argument is that an adviser is conflicted in their recommendation if they receive a placement fee.
We find the issues raised interesting because, as a general rule, we prefer to use unlisted managed investments which don’t pay commissions and work in a very different way.
We see the placement fee issue as a sideshow because the bigger deal is the nature of the LIC/LIT structure itself. This article explores the nature of a placement fee and moves on to a much bigger issue for investors in LIT/LICs.
What is a placement fee?
Current market practice is to pay a placement fee for capital raisings. The placement fee is typically funded from the capital raised.
It is a distribution fee typically paid to a broking house which may pass some of this on to brokers for distributing the offer of a listed investment to their clients. The purpose may be to raise capital for an existing business, the initial public offering (IPO) of a business, a raising for a listed investment vehicle such as an LIC or LIT or another type of equity or debt instrument to be traded on the ASX.
The contention raised in the press is some fund managers are willfully getting around Future of Financial Advice (FOFA) reforms by paying a placement fee to raise funds on market rather than via unlisted funds (which are not allowed to pay such a fee). By extension, advisers are accepting what would otherwise be regarded as conflicted remuneration.
The contention is that listed investment vehicles should be singled out and not be allowed to pay placement fees. The reason for them being singled out from other capital raisings is unclear but appears to be because they look like an unlisted managed investment. If a placement fee is deemed to be conflicted revenue, surely it is conflicted regardless of purpose of the raising?
Should placement fees be disallowed?
Perhaps. This is a question which should be asked and dealt with. But if so, would it not be more consistent to ban them for ALL types of capital raisings such as IPO’s, rights offers and purchase plans? You can’t have a ‘sometimes’ moral code.
Magellan has been headlined as questioning placement fees and their influence on adviser behaviour. And they have acted upon this by not paying a placement fee on their newest product to market. Whilst some may think this is an altruistic move to be consistent with FOFA, others might suggest it is a commercial masterstroke – a clever ploy that is on trend, enhancing the brand and capturing positive media commentary.
Magellan Financial Group is a giant in Australian funds management with a market cap of almost $9.5 billion and net profit after tax for the 2019 financial year of $364.2 million Compared to smaller fund managers, Magellan has the financial clout and proven track record to carry the costs involved with raising substantial capital in a limited timeframe.
If placement fees are disallowed, will the financial hurdle to raise capital in a new listed investment fund be too high? Could this lead to less diversity in the listed market? Would this outcome be in the best interest of market participants? If it is disclosed as a conflict to a prospective investor, is the investor sufficiently informed to make a decision?
LICs and LITs need to raise their funds up front. With the exception of exchange traded funds (ETF’s) they are not open ended. According to the ASX, the marketing and offer period is just three to five weeks. This is a remarkably short period to raise sufficient funds to make an investment vehicle viable post listing. Little wonder smaller operators pay a fee to outsource distribution.
What is the real issue?
We believe the real issue is that when a manager raises capital for a listed investment vehicle, they never have to give this money back.
The listed investment structure serves to permanently underpin a source of revenue for the investment manager. The listed structure best serves the interest of the manager and has no direct linkage to the investors realised outcome.
The big concern for investors is the propensity for listed investment vehicles to trade at a discount to net asset value (NAV) unless they continue to perform strongly.
According to Morningstar, at 31 July 2019, 14 of 20 Australian share sector LIC’s were trading at a discount to NAV and 6 were trading at a premium. In the International share sector, 30 of 34 LICs were trading at discount. Discounts of 20% are not uncommon. These discounts can dwarf placement fees paid at issue.
Whilst managers are aware of this and try to answer criticisms, there is no mandatory measures they must take to deal with it – their interests are not aligned with investors. Unlike open-ended unlisted funds, an investor choosing to sell must sell on the ASX to the most bullish willing buyer.
There is no mechanism to sell at a fair NAV. Manager fees, however, are based on the NAV and the performance of the underlying portfolio – the market price has no bearing on the fee they are paid. An investor can be severely underperforming on a listed investment company/trust which in turn is earning a fee in perpetuity based on a different mechanism.
Can the conflict be taken out of a listed investment vehicle?
To some extent, it can be. These are just a few suggestions:
Offer an investment in an unlisted open-ended vehicle with the same investment strategy on equal terms, with the ability to transfer units between an unlisted and listed vehicle of the same strategy without capital gains tax implications;
Limit asset-based fees calculation to the lower of NAV and traded price:
Introduce a mandatory wind up trigger where certain performance and/or regulatory hurdles are not met.
Conclusion
It’s not a simple thing to simply ban placement fees for listed managed investment offers. Perhaps with a concerted approach the regulators could come up with a better solution for LICs all round.
The debate to date has focused on alleged adviser behaviour in the face of placement fees being paid. This is perhaps understandable given the recent Royal Commission, but readers should not be blinded to other vested interests. Those taking the moral high ground are being diverted from the real issue for investors in listed investment vehicles.
Far outweighing placement fees is the lifelong benefit the hostage funds in listed investment vehicles give an investment manager and the management fees paid year upon year, irrespective of performance We believe that many listed investment vehicles are conflicted in their current format and investors are ready for a new solution.
Sovereign Wealth Partners assists clients in making the right choices for their portfolios.
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Cover Image- The Daily Dot 28/10/2016
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