One of the debates raging in the post GFC financial world concerns the relative advantages and disadvantages of investment structures. For example, many people have decided that “managed funds” are expensive, opaque and have bad returns. At the same time, there has been a substantial lift in the funds being invested into “Listed Investment Companies (“LIC’s”) and what are called “Exchange Traded Funds” or ETF’s. We are going to look at some of these issues. Keep in mind that it is Friday, so i’m likely to pontificate on a point here or there. Feel free to let me know if this is too verbose!
Price vs Value
This has been the great argument between labour and capital in the centuries since the agrarian revolution first heralded the impending onset of the Industrial Age, reaching an apogee in the Haymarket Massacre of 1886. We’d all like to be paid what we think we are worth – but there is usually a differece in perceived value, depending on whether you are handing over the money or the one providing the labour. In this post, it’s a lot easier. We are talking about “net worth”. When is a dollar worth 100 cents, and when is it not?
You may want to grab a glass of your favourite sherbet because the next paragraph is pedantic and boring… but it is important to understanding the world of money, so please persist…
We have previously covered some of the issues surrounding the “listed” versus “unlisted” asset arguments within super funds.
Unlisted Assets vs Listed Assets
The most public stoush in this regard has been the propensity of Industry Super Funds to hold larger allocations of “unlisted” assets such as buildings, utility, transport and development businesses. These assets are owned privately, which means that their value is only really determined when the specific assets are bought or sold.
In contrast, buildings, utility, transport and development businesses that are “listed”, are owned by groups of shareholders who agree to buy and sell their holdings through the Australian Stock Exchange (“ASX”). Obviously, you can transact quite small parcels of money on the ASX, so you are able to sell or buy just a fraction of any one of these assets. When you do, there is someone else who is buying or selling that parcel, and once you agree on a price we have a “last trade” figure that can be used to work out how much the entire building/company is worth, if the entire thing were to be sold at that price. That individual buy/sell of a parcel will often be transacted at a different price than would be the case were the entire asset underlying the shares to be sold. Here’s an example of that idea in action…
Global Mining Investments Limited
Firstly, remember the Great Disclaimer of this site. Nothing that is discussed, highlighted or illustrated on this site can be taken to be “personal advice”, as this site has no capacity to take into account your personal financial situation, objectives, attitudes to risk or preferences for tea over coffee. Therefore, you must not act on anything mentioned here without either discussing your situation with a suitably qualified Financial Planner, Accountant, neighbour, taxi driver or doing such appropriate due dilligence and research yourself.
OK… back to the point at hand. There is an investment company that is listed on the ASX that goes under the name of “Global Mining Investments Ltd”. Its market symbol is “GMI”, and you can look it up on the ASX website.
You can see that something strange has happened to the shareprice at which people are prepared to buy and sell this company, and it has been quite dramatic…
GMI is an investment company. The company website highlights the activities of the company.
You can see that the company shares have assets of $1.20 backing each share. For many companies – such as BHP, Wesfarmers etc, etc.. the assets backing the company shares will include “real assets” such as buildings, property, mining tenements, lease ownership, vehicles, equipment and cash. There will also be a value given for “goodwill”, which is pretty much the premium over the value of all those assets that the company thinks its name is worth if the company were to be sold. Obviously, some directors will have more positive or more conservative estimates of the value of that goodwill than the general marketplace or the consensus of the investors holding the shares. For example, BHP’s current asset backing is $11.69 per share – while the shares themselves are trading at $34.36 right now. Here’s a bit of a look at a few companies, and their respective asset backing versus their current share price…
Interesting, isn’t it? Obviously, nothing in the world of money is a simple as it seems, and there are various nuances around “NTA” – but the general idea holds true, which is that it is very difficult to have a precise value for a company share at any given point in time. It’s also true that most of the big companies in Australia’s sharemarket have a business value that is far greater than the net tangible assets backing the company, and that’s a good thing.
A full NTA – my Kingdom for a full NTA!
Well, in the case of investment companies such as GMI, their asset backing is predominantly a simple reflection of the value of their underlying investments. Companies such as GMI publish the value of their portfolio of holdings (generally monthly), so that their investors have an idea of what the company is worth. Now here’s the sting… IF you were to sell the entire portfolio of investments held by the company then you are likely to obtain the full net asset value – that’s because the assets themselves are predominantly listed shares. In other words, the prices that are quoted on the day are the prices for which you can DEFINITELY sell the assets. Outside of today/tomorrow/next week timing issues, you can be pretty sure that the assets you buy will have that value. There is no need to second guess the directors or valuers – the sharemarket itself is doing the valuing every minute of every trading day.
Here is a look at the assets held within GMI. You can see that these are major global companies, with high liquidity shares in large markets, so you will get a market price every day for these companies. If your NTA is a total of these exposures then you can be quite sure that the NTA is a genuine figure.
The website snapshot above shows an NTA of $1.20 per share as at the 27th April 2012. What were GMI shares selling for on that day? All trades on that day were completed at 92c. What the? Yes, 92c. That means every person who bought and sold a parcel of shares on that day, agreed that they were prepared to accept a bit over 76c in the dollar as being a “fair trade” value for the shares. IF the asset backing included a lot of out-of-date valuations or company director “best guesses” THEN you’d have to say “fair enough”… but it’s a lot more difficult to just sit and watch that sort of thing happen when you are a company director, and your job is to represent the best interests of the shareholders in the operation of the company. So, what does a self-respecting company director do? They get on with the job of making sure the shareholders have an opportunity to benefit from the full activities of the company they own. And that is just what the good folk at GMI have done.
The company has issued a statement that can be viewed on their website. In effect, the assets of the company are going to be transferred to an unlisted trust – at which stage the operators of that trust can set up systems to ensure that investors do receive the correct market value of the underlying investments on a given day, should they decide to sell or to buy into the fund.
Clearly, the sharemarket world loved the certainty this would bring, and so the price of the shares has been driven significantly higher. You may notice that it has still not reached $1.20. Sharemarket investors are a wary lot – the company may not get the approvals it requires, its costs may escalate; some of the investments may suddenly go bad. It’s unlikely that the shares will reach the underlying asset value until such a time as the transfer of assets is certain (it could also be that the global markets for mining company shares have fallen a bit since the 27th April, and investors may simply be factoring in that change of price).
Premium Investors (“PRV”)
This is another active fund manager, who runs a listed investment. The fund performance is apparently greater than the benchmarks it competes with, and yet one of the negatives to the listed company process is that negative earning years (such as during the GFC or 2011) can stop the ability of the company to pay dividends, owing to some international accounting standards or some such thing.
Many people buy these companies exactly for the dividend income, so when that stops it can have a devastating impact on shareholders individually. However, the directors here have also come up with help to deal with this issue – they have set up a “buy-back”, whereby every shareholder has the right to sell up to 2.5% of their holding, and receive the full NTA of the share – rather than have to sell at the shareprice on the market, which is at a discount to the NTA.
This is a great examle of a company taking care of its shareholders. It’s not ideal (as those investors who choose not to participate in the buy-back will have their share will be “out of pocket” by the difference between the market value and the buyback value) but the shares being purchased at the NTA will not affect the fund NTA – so no loss for the long term investor. It basically frees up some money that would otherwise have been paid out as a dividend.
Listed Investment Companies
There are a lot of these companies listed on the ASX. If there is sufficient interest, we can spend more time in other posts looking at the sector in more detail. For the moment, this is simply a Friday afternoon ponder of some of the more obvious issues that surround comparisons between the different types of managed funds that investors are confronted with when making a purchasing decision.
How does this differ from a managed fund?
In an unlisted managed fund, the fund manager guarantees to buy or sell the units of the fund at the relevant NTA. As usual, there are limitations and exceptions here and there but that is one of the basic benefits of the unlisted fund – you get what you pay for.
However, unlisted fund managers have other issues to deal with, such as marketing and distribution. These aren’t issues in a listed fund – as it is “closed”. ie, money is raised initially to set the company up and that is all the money that the manager has to worry about from there on (roughly). Investors who want to sell or buy into the fund have to do so through the ASX – leaving the fund manager free to worry only about the money they have under custody.
In an unlisted trust, the investors could withdraw big chunks of money. This will require the trust to sell assets to meet the redemptions. They may be liquid, and may be able to do so but the end result will be less opportunities, less scale and therefore greater fee pressure, and lower income to the fund manager – which brings about other business pressures. This is one of the reasons that marketing is so important for fund managers of unlisted trusts – if they do not keep their investors happy then they could end up having to close the trust altogether, and return money to the investors. The large fund managers such as AMP, MLC, BT and Colonial First State are generally protected from such outcomes owing to their sheer scale. It does form a barrier to entry for smaller players though, and this is one of the arguments against the unlisted funds industry.
Tax is different between the two entities, as well. i’m not going to go through all that in this post but if it is something you are interested in then you will easily find material on this aspect through a basic web search.
What does all this mean?
It means that anyone buying a listed investment company should pay close attention to the underlying assets of the company. It is easy to get carried away with the excitement of the market but care should be taken or you may find you pay too much – or that you buy a company share that may not reflect the true value of the underlying assets.
It also means that the comparison of “managed funds” – which are unlisted trusts, with listed investment companies involves far more than just the level of fees and the respective investment managers.
Listed investment companies tend to have lower ongoing fees than a managed fund does, and this is a big attraction for some people. The current extreme market focus on fees is a distortion of the full story, and the recent moves by a lot of retail managed funds to offer lower threshold wholesale options is making comparisons even harder.
What about ETF’s?
Exchange Traded Funds originally started out as simple “index funds”. In other words, you would buy the ETF to gain access to the underlying index that the ETF was built on. For example, one of the most common ETF’s is a simple Australian Share Index type. For example, the State Street Global “S&P/ASX 200 Fund (with the market symbol “STW”) holds its total assets in the top 200 shares listed on the ASX. It holds them in the same proportion as the index – in other words, if BHP’s value as a company is equal to 10% of the total market value then BHP makes up 10% of the STW fund. Why would anyone do such a thing? What about research and market cycles and sector rotation and stock-picking opportunties?
In an actively invested fund, you want your managers to be selecting which shares to buy or sell based on their research, knowledge, experience and understanding. However, this also means that at any given point in time, you have no idea of where your money actually IS… This clarity and transparency is often stated as a key reason why some people like investing through index style funds.
The idea behind an index is that there is no “stock picking”. The index includes both “good” and “bad” companies, and does not make a judgement other than to see if the company fits the requirements of having X shares available for trade at any given point in time, and the total value of the company is big enough for it to be included.
By not having to pay for huge amounts of research, company visits, analyst reports, etc, etc, etc… ETF’s are able to keep their fees low – very low. In STW’s case, for example, the annual cost of running the business is 0.286%pa. That is so incredibly low that you should save enough money over the long term to make up for any potential lower returns that may eventuate when compared to a fund that actively buys and sells shares.
Does an ETF provide full NTA?
Usually, they do. The reason is that managers of such funds set up arbitrate opportunities for sophisticated investors, which automatically bring the unit price into close correlation with the underlying index, and therefore with full NTA.
There are still times when this does not work – for example, around distribution times. However, it generally does a great job of making sure you can buy and sell within that ETF without worrying about whether you are selling below the value of the tangible assets.
ETF’s are growing in range
“Standard” ETF’s were basically share funds based on local or global market or sector indices. However, the boom in commodities has sparked massive interest in commodity based ETF’s – with underlying physical assets such as gold and precious metals. There are ETF’s that track a basket of mixed assets, and Australia has recently seen the release of ETF’s based on fixed income investments.
Some trends are self-fulfilling, and the barrage of new ETF’s is likely to continue.
Beware the Hype!
There is furious competition between providers of financial services in Australia. Ours is a sophisticated and mature market even by global standards. It is highly unlikely that you are going to read anything about ETF’s vs unlisted trusts that is not prepared by a vested interest, while the “active” versus “index” investment camps continuously release material presenting their respective approach in the best light.
Even within the ETF industry there are various ways of approaching the replication or copying of a particular index. This can leads to traps for the unwary – although the “standard” ETF’s are getting better at highlighting their respective points of difference.
For the individual, it is essential that they undertake full and relevant investigations into the scope of issues surrounding any decision to invest into or sell out of unlisted trusts, listed investment companies (LIC’s) or exchange traded funds (ETF’s).