Listed Investment Companies vs Index Funds in Australia

By | September 16, 2016

listed-investment-companies-vs-index-funds-in-australia-dividends-down-under-blogAuthor: Mr DDU.

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Choosing what to invest in is one of the hardest things about investing. There are so many different factors to consider: costs & fees, how geographically diverse the investments are, how many different industries the investments cover, the desired income and capital growth – the list goes on. How is an investor meant to know what to do?

 

Hit many birds with 1 stone

The widely accepted method by the personal finance community is to invest in the S & P 500 index (which is the 500 biggest companies in America). The S & P index buys a small slice of each company, so the investment is diversified into 500 pieces. This is a very simple, low cost, effective strategy. The S & P 500 has been growing over the long term and probably will keep growing over the long term indefinitely.

The S & P 500 index gets big ticks on the capital and dividend yield growth fronts. Not high on the yield side, but if the investment is big enough, it should provide a good growing income source beating inflation.

People tend to have a bias to invest in their home country. So Americans can rest easy knowing their S & P 500 index is a home grown investment. What about for Australians wanting to invest in Australian companies? We’ve written an article about how badly diversified our equivalent Australian index is, heavily weighted to a few, huge, financial companies. The Australian index sadly contradicts an index’s ideal objectives of being diversified with lots of companies in lots of industries.

 

Is there no way for Australians to be instantly diversified?

Other than buying our own shares in companies and creating our own portfolio with diversification, yes – there is another way.

They’re called Listed Investment Companies (LICs) and they’re listed on the Australian Stock Exchange just like any other company with their own ticker, share price and dividend yield.

A LIC’s sole aim is to invest shareholders’ money and achieve as good investment returns as they can. There are a lot of LICs out there, all with different strategies and sizes.

One of the biggest out there is the Australian Foundation Investment Company (ASX:AFI) which is around $6.4B in size.

AFIC does tend to focus on investing in big ‘blue chips’ but they don’t invest like an index fund. The best long term value for shareholders is AFIC’s aim, so they choose investments that fit this strategy. They list their top 25 holdings here. Just so we can compare it to an index fund, this is their top 10 holdings as a % of their assets:

8.45% Commonwealth Bank of Australia (ASX:CBA)

7.07% Westpac Banking Corporation (ASX:WBC)

4.41% BHP Billiton (ASX:BHP)

4.40% Wesfarmers (ASX:WES)

4.26% Telstra (ASX:TLS)

4.21% National Australia Bank (ASX:NAB)

3.60% Australia New Zealand Bank (ASX:ANZ)

3.24% Transurban (ASX:TCL)

3.04% Amcor (ASX:AMC)

2.94% CSL (ASX:CSL)

 

And as of today, this is the ASX200 index:

7.95% Commonwealth Bank (ASX:CBA)

6.40% Westpac Bank (ASX:WBC)

5.14% Australia New Zealand Bank (ASX:ANZ)

4.73% National Australia Bank (ASX:NAB)

4.15% Telstra (ASX:TLS)

4.13% BHP Billiton (ASX:BHP)

3.18% CSL (ASX:CSL)

3.11% Wesfarmers (ASX:WES)

1.98% Woolworths (ASX:WOW)

1.79% Macquarie Group (ASX:MQG)

As you can see it’s similar in some ways, and different in other ways. It’s true that AFIC’s dividends haven’t been as consistently growing as individual stocks like Ramsay Hospitals (ASX:RHC) or Invocare (ASX:IVC). That’s because Australia’s big businesses generally haven’t been increasing their dividends either. Consequently AFIC is starting to invest in medium sized growing businesses.

AFIC’s current dividend yield is 4.29%, with franking credits it’s 6.13%. Of course there’s more to dividends than just its yield, what about their dividend growth since 2009? Here’s the graph:

afic-asxafi-dividends

Not amazing, but reassuring.

 

There are also LICs that try to achieve the best return they can by being open to investing in shares on the smaller, faster growing side.

One of the most consistently successful LICs has been WAM Capital (ASX:WAM). WAM’s current yield is 6.30% and with franking credits is 9%. What about their dividend growth since 2009? Here’s the graph:

wam-asxwam-dividends

WAM also release a monthly update detailing their top holdings and how much cash makes up their total assets. Their 31st August 2016 update shows their holdings were:

31.7% cash

Portfolio top holdings:

3.1% Hunter Hall Global Value (ASX:HHV)

2.1% Smartgroup Corporation (ASX:SIQ)

1.9% Vita Group (ASX:VTG)

1.9% Nick Scali (ASX:NCK)

1.9% Aristocrat Leisure (ASX:ALL)

1.7% Credit Corp Group (ASX:CCP)

1.7% ALS (ASX:ALQ)

1.6% RCG Corporation (ASX:RCG)

1.6% Century Australia Investments (ASX:CYA)

As you can see they have a lot of cash. Their portfolio is completely different to the index and AFIC’s top holdings.

A lot of WAM’s shares aren’t classic long term dividend stocks (in our eyes). They have still outperformed the ASX200 Accumulation index (index plus with dividends re-invested) nearly every year since it was launched. WAM also provides a very nice amount of income with its high yield.

 

Final thoughts

When looking for a single investment that hits multiple birds with one stone, we are wary of options that are overweighted by the financial sector, like the ASX200. It’s possible to get great diversification if we look away from Australian indexes and turn to LICs instead.

We said in our August 2016 Savings Rate that we weren’t going to frivolously spend our tax refund. We wanted to use it to help our future selves, so we decided to put a portion towards a small investment. It may or may not be related to this article, so keep your eyes peeled for that.

 

Thanks for reading this article about our investing journey Down Under.

Onwards and upwards!

20 thoughts on “Listed Investment Companies vs Index Funds in Australia

  1. ambertree

    Interesting that in Australia you have active funds that quote on the stock exchange. The ones I use for now are traded off exchange with a price fixing once a day.

    Are any of these also internationally diversified?

    As a Belgian, it is hard to stick to our home bias. Some of the BEL20 stock are actually foreign stock that also quote on Brussels.

    1. Dividends Down Under Post author

      Australia also has active funds, these are a bit different I suppose. There are probably some that are internationally diversified, but I think we’d probably just go for the S & P 500 – at least most of our international investments would be focused there.

      I can see why you can’t focus on local businesses – there just aren’t enough!

      Mr DDU

  2. The Green Swan

    Interesting post, I enjoy reading posts like this that present things from the Australian viewpoint. It’s very educational. I guess I take it for granted having such great and easy diversification with the domestic S&P 500. On top of that I get geographic diversification with a few international index funds which are broad based (no one specific country).

    1. Dividends Down Under Post author

      Glad you found it interesting JW, that is one of the things we like to do – let non-Australians know what our country’s finances are like. It would be interesting to see what Americans would do if the S & P was actually in Europe – investing overseas is always seen as a riskier choice, even if it’s better.

      Mr DDU

  3. ADI

    I LOVE some of the LICS listed on the Australian exchange. More than a few of the older style LICs have MERs less than 30bps, and a few in particular have long term strategies focused on providing a consistent and growing stream of dividends. These LICS actively search out companies with the ability to pay growing dividends as well, so their top holdings can be a great source of ideas!

    A few of my favourites are BKI, MLT and WHF. WHF in particular is currently trading at a 12% discount to NTA and has an exceptional five year record. It also focusses mainly on industrials, which is another positive in my opinion.

    I’m less enamoured with some of the newer style LICs which, while they have performed pretty well, have large amounts of fees. I’ll take the old style anyday.

    1. Dividends Down Under Post author

      I agree ADI – it’s very interesting looking through their top holdings sometimes it makes me question our thinking when they have quite a few holdings that what we wouldn’t ever buy. That’s a good reason to buying them I guess – that way you’ve covered lots of companies we won’t own.

      I suppose we have to look at their net return after fees, if they’re still better than they’re worth it – if not, then they’re not. They’re skillful if they can outperform the ASX Accumulated index for most years in a row.

      Mr DDU

  4. Mustard Seed Money

    This incredibly interesting. Being an American I have taken for granted the ease of diversification that I receive through the S&P 500. It’s incredibly interesting to see what you must do to properly diversify yourself. For the most part I am mainly invested in the S&P 500 with a small exposure to International. But I may need to broaden my horizon as I continue to learn more.

    1. Dividends Down Under Post author

      The S & P 500 is a great vehicle to diversify your investments. There is no ‘right’ way to invest, but just choosing the S & P 500 hits a lot of the age-old advice like diversification. Your money is in good hands!

      Mr DDU

  5. Finance Solver

    Whoa I had no idea that the Australian index was biased toward financial stocks. Learn something new every day, right? I don’t know if I’ll ever break free from the home bias that exists but I think I want to conquer one country at a time.

    I actually did zero research when investing into the S&P 500 (my retirement account is 90% s&p and 10% bond). I have no idea which companies are comprised in the index but Warren Buffett likes the index and can’t go wrong with him ;).

    1. Dividends Down Under Post author

      Sadly yes, FS – we are heavily addicted to our financial stocks here in Australia. You’re right, WB appreciates the strength and depth of the S & P 500, so luckily that should suit most people very well.

      Mr DDU

  6. DivHut

    Sometimes deciding what to invest in is easier than the dreaded what to sell decision. You bring up a classic debate among many long term investors… Funds vs. individual stocks. I never heard of LICs before but they seem to provide that adequate diversification an investor wants in one fell swoop. Of course, as you mentioned, you have to watch out what they invest in. I agree that LICs that are over weighted by the financial sector would not appeal to me either. It seems like in the U.S. we have too many funds to choose from as new ETFs are sprouting up often. Thanks for introducing us to LICs and the Aussie indexes.

    1. Dividends Down Under Post author

      There are so many different options Keith, it’s hard to know what to pick! I like the idea of LICs (as long as their strategy and holdings match our thoughts) – perhaps there’s room in our portfolio for 1 or 2.

      Mr DDU

  7. Team CF

    Seems like a smart idea to broaden your investment horizon, the diversification is always a good thing from a risk management perspective. Besides our dividend stocks, we also have two ETF’s that are spread over a total of approximately 2300 companies. It’s a bit different from what LIC’s you just evaluated, but still. Think you should go for it!

    1. Dividends Down Under Post author

      Wow, 2300 is a very diverse range – you are very diversified with those! We do think having a couple of LICs in our portfolio does make sense, so you’ll see them pop up in purchases over time 🙂

      Mr DDU

      1. Team CF

        The good thing about ETF’s is also that they have a relatively low management fee on top of the great diversification. These two reasons, plus a few other, made it a simple decision to buy these two funds.

        Looking forward to your next posts on the purchase!

  8. Mr. PIE

    What are fees like in these LIC’s? How do they compare to a typical index dund over here in the US like VTSAX or VTIAX? I read all sorts of stuff from the UK about paucity of funds with low fees and wondered how assets under management (active or passive) in index funds or index like funds are looking in Australia

    1. Dividends Down Under Post author

      Hi Mr Pie.

      There are cheap funds/ETFs in Australia, such as Blackrock’s ASX:IVV which is a S&P 500 ETF with a fee of 0.05% – I’m sure we will start buying pieces of that at some point.

      Of the 2 I mentioned in the article, AFI has a fee of 0.16% – not bad. Its purchases are ‘active’ but it doesn’t do much selling.

      WAM has a fee of 1%, plus 20% of the out performance of the ASX200 Accumulation Index (ASX200 Index + dividends re-invested) if it outperforms the index. It’s a high fee, but they’re worth it.

      http://wilsonassetmanagement.com.au/wp-content/uploads/2016/09/2.-WAMNTA-August-16.pdf outlines their performance for many different timeframes. On a per annum basis:
      Since inception (Aug 1999) they’ve returned 18.4%, compared to the ASX200 Acc Index’s 8.1%
      10 years: 13.9% versus 5.3%
      5 years: 18.7% versus 9.5%
      3 years: 19% versus 7.1%
      1 year: 28.3% versus 10.3%
      6 months: 20.3% versus 14.2%

      Plus, because their dividend yield is so high, the extra franking credit return we get is a huge 3% yield boost, which alone makes up for the extra costs. But the outperformance is worth it in our eyes – they’re one of the top 2 performing LICs in Australia over the last 10 years.

      Mr DDU

  9. Adventures with Poopsie

    We are solid index investors. I certainly get the argument about lack of diversification, but we have sought diversification through also holding an international index, a property index (REIT) and also investing in the residential property market. We have certainly been happy with the dividends we have received thus far.

    1. Dividends Down Under Post author

      You have created your own diversification, so good job AWP. It’s important to be diversified both geographically and by industry. WAM can’t give the international diversification but I think it can play its part in our portfolio 🙂

      Mr DDU

  10. Calvin hague

    I will point out that Betashares has recently introduced an ETF with ticket symbol EX20 that invests in the ASX 200 and excludes the top 20 shares thereby providing a simple index fund that diversifies the ASX200 instantly.

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