Jun 19, 2019
Welcome to FF – SWW- answer questions from each of you – this
week from Sebastian
Hey Louis. I've been thinking about the pro's and con's of
Managed Funds vs LICs/LITs. It occurs to me that one of the main
disadvantages of managed funds is their open-ended nature.
In a crash, A manager of a fund is disadvantaged in this
situation because they are having to redeem fund units as panicked
investors sell out at a time they should be deploying cash into the
market. Closed-ended LICs and LITs don't have this problem.
What do you think about this - and should it impact our choice
of investment vehicles? Thanks, loving the podcast as always!
Great question! WARNING: No advice, just providing general
examples of when things work, when they don’t – on with it
Few things to clear up – have to run through open/close ended
funds, what are MFs/LICs/LITs, the risks/benefits of each and which
one experiences the worst outcome in a ‘bank run’ on an investment
– people wanting their money back all at once
First – Quickly run through Managed Funds, LICs, LITs
These are the structures that hold the underlying assets
- Managed Funds – Trust structure – therefore, open ended
structure
- Buy – Buy units with the manager – they then create these, pool
your money in line with other investors money – Sell – tell
manager, they sell your allocation to shares, you get the cash,
units are no more
- This is called open ended – as many units that are needed are
created, or sold
- Income – Distributions – Trust structure, so they pay no tax
and pass on all income, or gains to you
- =Dividends, Franking Credits, Realised capital gains (that
isn’t reinvested)
- Listed investment companies - LICs are incorporated as
companies - closed-ended funds
- Like any share – you need to cap supply - issue a fixed number
of shares on initial public offering (IPO)
- Buy – Have to buy off someone who holds shares and wants to
sell –
- This means they do not regularly issue new shares or cancel
shares as investors join and leave the fund. Instead, they ,
and investors must buy and sell those shares on ASX.
- This closed-ended structure allows the fund manager to
concentrate on selecting investments without having to factor in
money coming into or leaving the fund. This stability can be of
assistance to managers who take a long-term approach to
investing.
- As companies, LICs have the ability to pay franked
dividends.
- Listed investment trusts - LITs are incorporated as trusts,
rather than as companies - also closed-ended vehicles
- investors buy and sell existing units on ASX – hybrid between
the two – buying managed funds from someone else – not manager
- Listed investment companies (LICs) and listed investment trusts
(LITs) make up the majority of the listed managed funds on ASX
- Focus on Managed Funds and LICs/LITs – open versus closed
Pricing of each investment option
– Unit price versus share price – differs in how they are priced
and what is the value
- Managed funds and ETFs are priced at (or near for ETFs)
the net asset value (NAV)
- NAV - total market value of the fund's
investments, cash and cash equivalents, receivables and accrued
income.
- The market value of the fund is computed
once per day based on the closing prices of the
securities held in the fund's portfolio
- Unit Value = net value/number of units in fund
- Example – MFA currently holds 10 shares (nothing else – just
one company) – each share = $10 = $100, then If there are 10 units
– Unit price would be $10
- Someone buys 10 more units – does the price go up? No – Use
your money to buy 10 more shares – Now the NAV is $200, but unit
price is still $10
- If the shares MFA holds go up in value – to say $20 – NAV =
$400, Price = $20
- Close ended funds – trade at a discount or premium to their
NAVs based on the demand from investors
- premiums - result of a greater number of buyers
than sellers in the market
- discount - results from more sellers than buyers – supply and
demand for the share
- What we get here is where like any share – people will pay more
for it if they think it will go up
- Some of the best LIC managers have traded at 20% above NAV –
due to good past performance
- But then long term investors take their profits and the price
drops – not the NAV
- LICs and LITs are closed-ended funds that normally trade at a
discount or premium to their net tangible asset (NTA) backing
- market determines the price around the supply and demand of the
share itself – Open ended prices are set by the value of the
underlying assets – which is a much broader supply and demand –
between all of the assets they hold, rather than the demand for
their units
- A lot of this comes from Fund Transparency Difference and
supply/demand of investments
- The greatest difference between ETFs and CEFs is how
transparent each fund is to the investor. ETFs are highly
transparent because ETF fund
managerssimply purchase securities that are listed on a
specific index. Stocks, bonds and commodities held in an ETF can be
quickly and easily identified by reviewing the index to which the
fund is linked. However, the underlying securities held within a
CEF are not as easy to find because they are actively
managed and more frequently traded.
- Supply V Demand – if you are focused on the price of the asset
more than what is underlying it, get mismatch in prices
These are all structures
– You can get a Managed Fund that loses all of its value while
an LIC does well -
What matters more are the Investments, and their styles - broad
categories:
- Investments
- Australian shares funds invest principally in ASX-listed
shares.
- International shares funds invest principally in shares listed
on international stock exchanges.
- Australian or International Bonds, or other debt
instruments
- Alternatives – Commodities,
- Private equity funds invest in Australian or international
unlisted companies.
- Specialist funds invest in special assets or investment sectors
such as wineries, technology companies, resources businesses or
telecommunications providers.
- Investment approaches in some specialist, private equity, or
unlisted funds are the cause for redemption concerns
- If new units are created and the investments are easily
purchasable and liquid – low risk
- If new units are created but the investment is in an illiquid
asset – wait times for cash out
- REIT – Can be open or closed-ended – something to watch out
for
- Example – property crash occurs –
- Open ended – People want cash back from manager – managers have
to sell property to keep up with redemption demands – so they
freeze fund – do a firesale and give the unit holders whatever is
left –
- Seen mortgage funds with 2 cents back from $1, and property
trusts with 20 cents back per $1.
- Closed ended – people want cash back, people sell to those
willing to buy – prices drop
- Listed REITS – people sold back in 2008-2010 – prices of assets
dropped 85%
- Direct shares – Stockland - $8.50 to $2.20 from end of 07 to
start of 09
- Performance in a downwards market – share funds can retain cash
and invest it for you, other funds, cant, so cant capitalise and
survive and correction – make sure whatever you are buying in these
structures doesn’t have a large allocation to illiquid investments
– or ones that can go down massively in prices
What is the risk
Are managed funds (open ended) as a greater redemption risk
compared to closed ended
- Depends on the circumstances and types of investments held
- Always check the mandates/PDS – how long does it take to get
your cash out?
- Where the redemption risks are depends on the type of
investment that is held in the Managed Fund structure
- the underlying asset are in direct property or mortgages, then
the funds sometimes need to freeze redemptions and do a fire sale
of the underlying assets to meet the investments withdrawal
requirements. Unfortunately though, this is often at a fraction of
the original unit price.
- It is slightly different for listed investments that are easily
redeemable, such as shares. The redemption process of managed funds
for shares simply requires the manager to sell your parcel of
shares per unit and then the funds are withdrawn to you in a 3-5
business day timeframe (for Australian shares). As they are open
ended funds, new units are created when someone invests money and
more of their underlying holdings are purchased.
- The real risk is that the price of the units is only updated at
the end of the day at which point they can be sold or purchased. So
the risk isn’t so much from redemptions reducing the value, but
from not being able to sell at any other price than that of the
market close prices.
- For Closed ended funds, these can often be very volatile
because their value can greatly fluctuate based around market
demand (unlike the Net tangible asset price for open ended funds).
Shares can trade at a deep discount, and it can often be difficult
to realize the true value of the LIC structures are they don’t have
the same pricing mechanics. I.e. for LICs, as their prices are
determined by the demand for the share, they can move much more in
price regardless of their underlying asset values.
Thanks again for the great question and speak to you soon.
If you want to get in contact you can do so here.