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

  1. Managed Funds – Trust structure – therefore, open ended structure
    1. 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
      1. This is called open ended – as many units that are needed are created, or sold
    2. Income – Distributions – Trust structure, so they pay no tax and pass on all income, or gains to you
      1. =Dividends, Franking Credits, Realised capital gains (that isn’t reinvested)
    3. Listed investment companies – LICs are incorporated as companies – closed-ended funds
      1. Like any share – you need to cap supply – issue a fixed number of shares on initial public offering (IPO)
      2. Buy – Have to buy off someone who holds shares and wants to sell –
        1. 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.
      3. 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.
      4. As companies, LICs have the ability to pay franked dividends.
    4. Listed investment trusts – LITs are incorporated as trusts, rather than as companies – also closed-ended vehicles
      1. investors buy and sell existing units on ASX – hybrid between the two – buying managed funds from someone else – not manager
    5. Listed investment companies (LICs) and listed investment trusts (LITs) make up the majority of the listed managed funds on ASX
      1. 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

  1. Managed funds and ETFs are priced at (or near for ETFs) the net asset value (NAV) 
    1. NAV – total market value of the fund’s investments, cash and cash equivalents, receivables and accrued income.
      1. 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
      2. Unit Value = net value/number of units in fund
    2. 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
      1. 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
      2. If the shares MFA holds go up in value – to say $20 – NAV = $400, Price = $20
    3. Close ended funds – trade at a discount or premium to their NAVs based on the demand from investors
      1. premiums – result of a greater number of buyers than sellers in the market
      2. discount – results from more sellers than buyers – supply and demand for the share
    4. What we get here is where like any share – people will pay more for it if they think it will go up
      1. Some of the best LIC managers have traded at 20% above NAV – due to good past performance
        1. But then long term investors take their profits and the price drops – not the NAV
      2. LICs and LITs are closed-ended funds that normally trade at a discount or premium to their net tangible asset (NTA) backing
        1. 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
      3. A lot of this comes from Fund Transparency Difference and supply/demand of investments
        1. 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.
        2. 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:

  1. Investments
    1. Australian shares funds invest principally in ASX-listed shares.
    2. International shares funds invest principally in shares listed on international stock exchanges.
    3. Australian or International Bonds, or other debt instruments
    4. Alternatives – Commodities,
    5. Private equity funds invest in Australian or international unlisted companies.
    6. Specialist funds invest in special assets or investment sectors such as wineries, technology companies, resources businesses or telecommunications providers.
  2. Investment approaches in some specialist, private equity, or unlisted funds are the cause for redemption concerns
    1. If new units are created and the investments are easily purchasable and liquid – low risk
    2. If new units are created but the investment is in an illiquid asset – wait times for cash out
      1. REIT – Can be open or closed-ended – something to watch out for
    3. Example – property crash occurs –
      1. 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 –
        1. Seen mortgage funds with 2 cents back from $1, and property trusts with 20 cents back per $1.
      2. Closed ended – people want cash back, people sell to those willing to buy – prices drop
        1. Listed REITS – people sold back in 2008-2010 – prices of assets dropped 85%
        2. Direct shares – Stockland – $8.50 to $2.20 from end of 07 to start of 09
      3. 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

  1. Depends on the circumstances and types of investments held
    1. Always check the mandates/PDS – how long does it take to get your cash out?
  2. Where the redemption risks are depends on the type of investment that is held in the Managed Fund structure
    1. 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.
  3. 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.
    1. 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.
    2. 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.

Furious Friday: Could social security be the greatest Ponzi scheme ever?

Furious Friday Could social security be the greatest Ponzi scheme ever? Welcome to Finance and Fury, Furious Friday! I saw an ad this week for a movie called ’Wizard of Lies’ – Bernie Madoff movie – 2008. He was a stockbroker, investment adviser and financier who made...

Furious Fridays: The secret to mobilising masses

Hi everybody and welcome to Finance and Fury the Furious Friday edition. Today’s episode is the Stages of Socialism Part 3 – the series talking about politics. The first episode was about the Fabians and their strategies, then we addressed the political spectrum and...

Say What Wednesday: Getting tied up with Investment Bonds

Say What Wednesdays Getting tied up with Investment Bonds Welcome to Finance and Fury’s ‘Say What Wednesday’ where we answer your questions on personal finance. Today’s question today comes from William who asked us to do an episode on Investment Bonds. Investment...

How to best invest for Children or Grandchildren?

Welcome to Finance and Fury, The Say What Wednesday Edition This week's question comes from Cameron "One small question we have been pondering. Our parents are gifting a small amount of money monthly to our 1yr old son (their grandchild). Rather than let in mature in...

Current Australian Share Market

Episode 39 Current Australian Share Market Welcome to Finance and Fury Shares are at almost the same price as 2 years ago in Australia – What is happening? Mid Dec 2016 – 5,580 and last week the 3rd of December – 5,667 Today – is it a great time to buy some shares or...

How to use your home for Investments

Welcome to Finance and Fury Today we have Jayden here, and we will be talking about using your home for as an investment and as a forced savings account. You can start turning the bad debt into good debt. Through paying down the loan quicker, and then redrawing on the...

Who is responsible for your happiness and financial wellbeing?

Welcome to Finance and Fury Looking around in Australia - increasing disparity in wealth, and social fragmentation That social fragmentation means Australians are become "more self-interested, more materialistic, more competitive". Our largest challenge as a society...

Say What Wednesday: What is the real danger behind Climate Change?

Welcome to Finance and Fury, the Say What Wednesday edition. Today we are going to cover off on Climate Change. This may be a bit weird. But, the majority of proposed solutions are political/economic. Firstly, the taxation on CO2 emissions. What is this going to do to...

When property will work – and when it won’t! Quick tips for property investment

Episode 13 When property will work – and when it won’t! Quick tips for property investment Welcome to Finance and Fury Quick tips to help with making successful investments in property When property will work – and when it won’t! It is two-fold – How well the property...

Pay more in taxes, electricity prices and costs of goods, or the climate will change!

Welcome to Finance and Fury, The Furious Friday edition Today – cover Resource control over an economy/society – Energy, food, water – Many SDGs – 7, 13, 15, 16 – Mainly focus on 7 and 13 – this is the core of most SDGs – justifications for them anyway Goal 13:...

Pin It on Pinterest

Share This