Why the Listed Investment Company (LIC) Sector Appeals to SMSFs

The unpredictable year that was 2020 saw many listed companies withdraw their earnings guidance and significantly reduce or remove their dividend payments.  Many self-managed super fund (SMSF) trustees who rely on dividends from their investments as their primary income were dramatically impacted by these reductions in dividend payments. 

Looking back to August 2020, only 69% of ASX 200 companies elected to pay a dividend. That figure is down from 87% of companies that reported half-year earnings in February 2020 and 88 % that paid dividends in the August 2019 full-year reporting season*.

Traditionally, the big four banks have paid by far the biggest dividends, however in April 2020, APRA pressured lenders to preserve capital and freeze their dividends. As a result, Westpac and ANZ did not pay out a dividend in the first half of the year. It wasn’t just banks that slashed/removed their dividends. Companies including James Hardie (ASX: JHX), Challenger (ASX: CGF), Qantas (ASX: QAN), Transurban Group (ASX: TCL) and Sydney Airport (ASX: SYD) all followed suit. 

What we saw throughout the February 2021 reporting season was a return to dividends, but it is evident there is still some way to go. In the six months to December 2020, 79% of the ASX 200 companies elected to pay a dividend, however the average over the past 20 reporting seasons stands at 86%. 

Although many listed investment companies (LICs) were not immune to the market volatility of 2020, many long-standing LICs have retained or increased their dividends to shareholders this year, proving their resiliency in unprecedented times and accommodating their shareholders who desire income. LICs are often a popular investment for SMSFs due to their ability to pay consistent dividends, irrelevant of market conditions. This contrasts with exchange traded funds (ETFs) which must pass on all profits realised to unit holders each year. LICs can retain profits in a reserve for future years, which enables investors to receive a consistent income stream.

As the name suggest, a LIC is a company, and as such pays tax on its profits at the applicable corporate tax rate. This means that any dividends paid by the LIC may be partially or fully franked. 

Franked dividends have a franking credit, also known as imputation credits, attached to them. For SMSFs, the imputation credits can be used to reduce the SMSF’s tax liability. As the income of a SMSF is generally taxed at the concessional rate of 15%, if the dividend received by the SMSF is fully franked at the corporate tax rate of 30%, then a SMSF may be entitled to receive some level of refund of the franking credits from the ATO.

Whilst LICs and LITs have many similarities they differ in how they pay income to their investors. LICs pays tax on their earnings and pay distributions to investors in the form of dividends, franked or unfranked. LITs and ETFs distribute all net income and realised capital gains to investors on a pre-tax basis and it is the investor who is liable to pay tax.

The table below outlines the key differences between LICs, Listed Investment Trusts (LITs) and ETF investment vehicles. All of these types of investment vehicles have their relative strengths and weaknesses meaning some may be more suitable to your investment needs and objectives than others. We recommend you seek financial advice to see what investments are most suitable to you. 

In an environment where interest rates are at record lows and are likely to remain low for the foreseeable future, investors are having to invest higher up the ‘risk curve’ to generate returns and investment yields. 

The message of 'lower for longer' interest rates has been heard loud and clear with Governor of the RBA, Philip Lowe, stating in February 2021[1]:

The Board will not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range. For this to occur, wages growth will have to be materially higher than it is currently. This will require significant gains in employment and a return to a tight labour market. The Board does not expect these conditions to be met until 2024 at the earliest.

As such, many SMSFs may need to review their current income investments and look to other investment sources for income. LICs may offer investors an alternative source of income and a way to diversify share market risk. It is important to note that a LIC dividend policy is set by the company’s Board, elected to act in shareholder’s best interests. As the LIC structure allows the company to retain some of their profits for future periods this can be appealing for SMSFs looking for consistent income, particularly in uncertain economic environments. 

When assessing whether a LIC is appropriate for your investment needs, key points to consider are:

• How long is the investment managers track record?
• How has the investment manager performed over their recommended investment period?
• How liquid is the LIC? What is the LIC’s history of capital management?
• Does the LIC have a history of paying a consistent dividend?
• What is the prevailing share price relative to the LICs NTA?
• How active is the investment manager with communicating and engaging with shareholders?

NAOS Asset Management seeks to protect investor capital whilst providing a sustainable growing stream of fully franked dividends and long-term capital growth above the relative benchmark index.

NAOS Asset Management Ltd (‘NAOS’) is a specialist fund manager providing genuine, long-term, concentrated exposure to Australian listed companies outside of the ASX-50. NAOS manages three LIC’s, being the NAOS Emerging Opportunities Company Ltd (ASX: NCC), NAOS Ex-50 Opportunities Company Ltd (ASX: NAC), and NAOS Small Cap Opportunities Company Ltd (ASX: NSC). For more information on the NAOS LICs visit www.naos.com.au 

[1] Reserve Bank of Australia – Statement by Philip Lowe, Governor:Monetary Policy Decision – 2 February 2021