LICs - are they all they're cracked up to be?

Incoming topic grenade

For the purposes of this article, LIC's will refer to the older LICs (AFI, ARG, MLT etc) and not the broader range of all LICs.

Usefulness of LIC's

Before indexing, you had a choice between picking your own stocks or actively managed funds. Neither of these are particularly attractive.

To pick you own stocks, you need to get down and dirty and learn all about each company's finances. Not only that, you need to actually understand it and try to predict if it will do well in the future.

The other option was having faith in a fund manager to pick your funds. Having faith when it comes to your money is a tough call. If you're like me, you don't want to rely on hope for your financial security.

This is where LIC's came in. They trade infrequently and are somewhat of an index proxy. Essentially, they are the closest thing to an index fund that was available. Like index funds of today, they are also low cost.

They still have some downsides to index funds, so I don't see much point in LIC's today when there is a better alternative, but I certainly don't consider LIC's to be a bad investment, they are just not anything particularly special, so while it is probably fine to go ahead and use LIC's in place of your Australian asset allocation (not your total asset allocation), the arguments that are put forward by LIC advocates unfortunately are almost entirely nonsense. I don't see how anyone can make an educated decision when they are being fed half-truths designed to convince you rather than educate you.

So, let's take a look at the arguments.

You can just live off dividends and not worry about the movement of the markets

Continues on link..

Side note #1

I personally hold some MLT

Side note #2

It was @Nodrog who informed me of some of Andrew's posts across various sites, his passive investing Australia site is an interesting read

Side note #3

There was no such thing as index funds when these Grandfather LIC's started trading in the 1930's & 40's



This post is purely to generate conversation on the passiveinvestingaustralia.com link
, it should also be noted there are a number of considerations and differences between US & AUS passive investing

Personally and if younger I would have done well if i'd followed the wisdom of @SatayKing @Nodrog @truong @Islay

Sadly, you don't know what you don't know, there have also been some great posts by @pippen @sfdoddsy @dunno etc of recent times on strategies

Not forgetting Property Chat and the property strategies of numerous well known posters here, who have done extremely well over the years on that strategy alone

 

Since I mentioned MLT I guess I should also add in the sidenote that I had six (6) investment properties across WA, QLD, NSW over recent years as well as oft mentioned ETF's

 

Here's a little known consideration in the ETF vs LIC debate for an expat who wants to keep some skin in the AU market. Do you choose VAS or MLT (or other LIC)?

Depending on your country of tax residence, dividends from funds may be taxed differently to dividends from companies.

Example: $1000 is invested in VAS and $1000 is invested in MLT. Both pay a fully franked dividend of $40. Residence country deems that Australia has taken the 15% witholding allowed under the DTA as non-residents can't use the franking credits.

Residence country taxes dividends like this:
30% on dividends from funds
25.5% on dividends from direct holdings in listed companies, this includes LICs

Credit is given for the 15% witholding, meaning dividends are now taxed like this:
15% on dividends from funds
10.5% on dividends from LICs

So after tax your $40 dividend becomes $34 if invested in an EFT or $35.80 if invested in a LIC.

Food for thought if you ever might become a non-resident for tax purposes...

 

From the LIC thread which is very similar to my thoughts on this now:

In regard to Andrew he has written some great stuff, I’ve read most of it overtime. He does a great job in explaining local vs global diversification from a currency perspective.

Rather than thinking of ASX vs International think in terms of Aus currency vs global currency. For example early on Andrew wanted to reduce ASX concentration risk so he considered allocating more to mid / small caps such as MIR, QVE and EX20. But these are still highly correlated with the rest of the market. But when he thought about it in terms of local vs global currency the solution became clear:

The solution - Hedged Global Equities eg VGAD for local currency rather than all ASX. Massive diversification compared to ASX mid / small caps in the same local currency. So no excuse for say a retiree to be concerned about currency risk when drawing on the assets for Liability Matching.

Of course there are tax benefits etc from owning ASX so it makes sense to have some allocation to it. But rather than holding an excessive allocation to ASX because of concerns about currency risk Hedged VGAD for example makes greater sense than trying to diversify against concentration risk through local mid / small caps.

This section from his site is well worth reading:

Currency risk - personalising your AUD to non-AUD allocation - Passive Investing Australia

 

Back on line now as I had to post and run (hence the hand grenade)

I just finished reading that link, there was a sub-link within that which went another page from the Globe & Mail quoted below

I've considered the hedging issue a few times but thought similar this

 

So to sum up:

K
I
S

 

If you delve deeply into comments on Canadian Couch Potato site when this topic has been discussed numerous times a lot of Dan’s comments you posted above have been proven wrong certainly in the case of Vanguard’s management of hedging.

That said I’m still not a fan of Hedged equities either as a “long term” asset allocation. I will however consider opportunistic buying of VGAD when the Local currency gets hammered. BUT when the Aussie dollar returns to more normal levels VGAD would be sold to purchase VGS which is a “long term” holding. This strategy is confined only to the SMSF given the tax issues associated with hedging and minimal CGT when switching from VGAD to VGS. From memory @dunno also takes opportunistic advantage of hedging using specific rules.

Outside of the SMSF I have no intention of holding Hedged equities, VGS only.

Unlike Andrew I still like to overweight local mid / small caps by holding the likes of QVE and MIR. I’m not as paranoid as those who believe because ASX is only 2 - 3% of global markets one needs to be fearful of holding a sizable allocation to ASX. Maybe if Pauline Hanson becomes prime minister I will reassess.

 

You forgot to take into account ME - KIS(S).

 

Wouldn't share markets be fairly well correlated to the local currencies?

 

Um, as the post was about my location I preferred not to reference myself in that manner. Modesty, humility, Self and all that.

 

So what exactly was the suggested portfolio?

 

Probably worth reading the section on "Building a passive portfolio", or having a look at the summary:

Summary, next steps, and further reading - Passive Investing Australia

 

The Australian version of the 3-fund-portfolio - Passive Investing Australia

Vanguard have all in one diversified funds such as VDHG as mentioned. However the below quote is the main reason I’m not so keen on them. In summary they periodically mess with the allocation, sometimes the changes are major as occurred a couple of years ago:

 

Thanks found it in the Investment Plan section:-

• 30.0% Global Stocks (VGS)
• 17.5% Global Stocks - AUD hedged (VGAD)
  
• 17.5% Australian Stocks (VAS)
• 30% Australian Bonds (VGB? or VAF)

As I have 2+ years living expenses in cash plus income from my super funds and part-time work, I think I would prefer now re-investing dividends and other funds internationally into both VGS and VGE so that I eventually transition my investment portfolio from:-

• 12% VGS

• 02% VGE

• 86% LIC/VAS

into something like

• 50% VGS
• 25% VGE
  
• 25% LIC/VAS

 

I can appreciate the reasoning for a larger allocation towards international.

Nevertheless Australia is where I live and intend to so my attitude it a greater asset allocation here than international.

Do investors in other countries have the same home bias? Put the USA aside as it considers it is the world and from one viewpoint it could very well be.

 

Home-bias investing: A global phenomenon

Andrew’s view is that “Hedged” global equities offers far greater diversification than the ASX and is in the same currency where a retiree is generally spending most of their income. Hence VAS and VGAD are considered Aussie currency equity allocation.

Trouble is depending on where the Hedged equity fund is held tax efficiency can be an issue. Also the income distribution are erratic and sometimes non existent for up to a year or two. They’re still there but sometimes end up in the capital account. So the investor needs to sell shares to effective get the income distribution at times. An investor who is comfortable drawing on / or needs to draw on capital likely doesn’t think this is much of an issue. However for the likes of me and @SatayKing this is sacrilege.

 

might be ok if perhaps you’re investing for the next generation but that’s a very aggressive allocation for a retiree.

 

This paper by Vanguard discusses the issues such as diversification, asset allocation, home country bias, hedging etc which are taken into account when constructing their Diversified Portfolios:

https://static.vgcontent.info/crp/i...g-australian-diversified-funds-whitepaper.pdf

 

Ah I see. The perennial argument for certainty which crops up from time to time.

Apparently contrary to the view of the old hypocrite* WB who proposed if you get $33k pa in dividends you don't need to hold much cash. It implied you weren't selling anything or incurring CG and it was pure dividend income.

* suggests that but doesn't apply the principle to the share holders of BH.

No idea who Andrew is sorry. I rarely, if ever, read articles which are posted.

Heresy. Burn the witch!

 

That is just an example. The website doesn't prescribe a set %, but the preferred investment mix is here as linked by Nodrog.

At the end of the day you have to decide your allocation mix based on what is best for you.