Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 308

Did LICs just dodge a political risk bullet?

With the election complete, retirees around the country have claimed victory in opposing Labor’s ‘retiree tax’ on franking credits. Zenith suspects that this may come as cold comfort to those who had already repositioned their portfolios in an attempt to front run the proposed changes given a Labor win looked likely.

During the course of the election, many questions were raised, including:

  • What is the future of Listed Investment Companies (LICs)?
  • Would legislative changes herald the death of the company structure?
  • Should LIC investors consider seeking yield from other asset classes or investment structures?

The Labor impact on LICs

Looking at LIC trading as an indicator, market sentiment experienced a decline post Labor’s announcement on 13 March 2018. When measured by their prevailing premium or discount to NTA, the LIC market materially de-rated as investor uncertainty took hold.

Obviously, Labor’s announcement was not the only aspect at play, as the market had already been de-rating some LICs trading at high premiums to NTA (some trading at 20%+). However, the political impact was a factor, particularly given Australian equity LICs had the largest premiums prior to Labor’s announcement.

The following chart highlights this change by comparing each LICs/LITs prevailing premium or discount to net assets as at 13 March 2018 (when Labor’s policy was announced), compared with 30 April 2019. [Note: we have elected not to label each vehicle as this is less about the individuals and more about the broader trend].

Click to enlarge

With Labor losing to the Coalition, we expect some level of positive re-rating for some of the LICs/LITs. However, this raises other interesting questions.

In the run up to the election, many commentators thought Labor’s proposal would ultimately address retirees' strong home bias, as it meant people would effectively be encouraged to diversify away from portfolios traditionally heavy in fully-franked equities as a source of yield.

But, with investors having just passed through a politically driven near-death experience, how might the search for yield change? Will LICs investing in Australian equities remain attractive as an investment tool?

Zenith believes there are two essential elements to consider: the return characteristics of asset classes and the structural differences of utilising a company versus a trust.

Where’s my yield?

Prior to the election, the question uppermost in the minds of those who stood to lose franking credits (i.e. 0% tax payers) was where to find replacement income. The realistic answer is that this was not easily done without making major compromises to asset allocation.

[Note that for the purposes of this report, we are not considering other structural avenues such as changing to industry funds].

The following chart summaries current yields available from various asset classes as at 30 April 2019.

Click to enlarge

Australian equities have traditionally been a high-yield investment. While this has been driven in part by the taxation perspective, Australians have long expected to derive income from equities. However, even when removing the impact of franking credits, Australian equities are still one of the highest-yielding assets classes which are available in a liquid, diversified format.

While listed property in the form of Australian REITs runs a close second when removing tax implications, a major shift into REITs is unlikely to be conducive to adequate risk management and portfolio diversification. In sidestepping the franking issue, other investment risks come into play.

Based on Zenith’s long-term market assumptions undertaken by our portfolio consulting team, the long-term expected returns versus their historical risk levels is shown in the chart below for the major liquid asset classes.

Click to enlarge

From a portfolio construction perspective, lowering the returns available from Australian equities by removing franking would have reduced their allocation in portfolios from an optimisation perspective (the impact of lower returns for the same risk). While feasible, this has two glaring outcomes. Firstly, substituting other assets classes simply introduces other risks and secondly, it still fails to address the question of replacing income for current retirees.

Investors could also invest in other income-producing securities. Some private markets such as real estate, infrastructure and credit can also deliver stable yields at attractive levels. However, is that the right move? Ultimately, Australian equities still hold a key position across the asset classes from a yield perspective.

For LIC’s, it would be reasonable to expect that this will continue in the foreseeable future. So, the next logical question is, does the structure of listed vehicles have a bearing on income generation?

LICs or LITs? Which works best?

The rise of Listed Investment Trusts (LITs) has been a relatively recent phenomenon, brought increasingly into focus as the arguments around franking mounted. The key difference between the two structures is the way income and capital gains are treated.

For LICs, under the company structure, dividends and capital gains are treated as income, contributing to the profit and loss position. The company pays tax on earnings and pays dividends (franked or unfranked) at the Board's discretion. A company can elect whether to pay dividends and can smooth cash flows using retained earnings from one year to the next. The company may chose to decrease the volatility of the income stream to investors. This has traditionally been a highly-attractive feature of LICs when dealing in an inherently volatile asset class like equities, provided the earnings (retained or otherwise) are there to fund dividends.

As trusts, LITs distribute all net income in the year received, along with any realised capital gains on a pre-tax basis. The investor is liable to pay tax. As a result, LITs pay no tax and therefore have higher cash earnings to be paid out. However, their income streams are more likely to be unpredictable, fluctuating with the manager’s investment activity. While LITs do have the ability to offset these fluctuations somewhat through returns of capital, there is still less control compared with LICs.

Zenith believes that the key determinant of the preferred structure for managers is the asset class, investment strategy and objective. For Australian equities managers, particularly those with high levels of portfolio turnover, a company structure is arguably more conducive to the generation of a stable dividend stream to shareholders.

For asset classes where income generation at the security level is more predictable, such as fixed income, or where assets or strategies tend to generate less income, such as global equities, a trust structure may be more attractive.

Given the position of Australian equity LICs in generating stable dividend streams from an asset class with comparatively high volatility, Zenith believes the LIC structure will  continue as a core part of the listed investment market.

However, despite a Coalition victory, the issues around the cost of imputation to the government remains a moral hazard. Zenith believes that all investors, regardless of their current position on the road to retirement, must be cognisant of the consequences of political risk to their portfolios and ensure where possible that adequate planning for flexibility is undertaken.

 

Dugald Higgins is Head of Property and Listed Strategies at Zenith Investment Partners. This article is general information and does not consider the circumstances of any individual investor.

 

RELATED ARTICLES

Why LICs may be close to bottoming

The fascinating battle between Nick Bolton and Magellan

Why LICs are closing and more should follow

banner

Most viewed in recent weeks

16 ASX stocks to buy and hold forever, updated

This time last year, I highlighted 16 ASX stocks that investors could own indefinitely. One year on, I look at whether there should be any changes to the list of stocks as well as which companies are worth buying now. 

UniSuper’s boss flags a potential correction ahead

The CIO of Australia’s fourth largest super fund by assets, John Pearce, suggests the odds favour a flat year for markets, with the possibility of a correction of 10% or more. However, he’ll use any dip as a buying opportunity.

2025-26 super thresholds – key changes and implications

The ABS recently released figures which are used to determine key superannuation rates and thresholds that will apply from 1 July 2025. This outlines the rates and thresholds that are changing and those that aren’t.  

Is Gen X ready for retirement?

With the arrival of the new year, the first members of ‘Generation X’ turned 60, marking the start of the MTV generation’s collective journey towards retirement. Are Gen Xers and our retirement system ready for the transition?

Why the $5.4 trillion wealth transfer is a generational tragedy

The intergenerational wealth transfer, largely driven by a housing boom, exacerbates economic inequality, stifles productivity, and impedes social mobility. Solutions lie in addressing the housing problem, not taxing wealth.

What Warren Buffett isn’t saying speaks volumes

Warren Buffett's annual shareholder letter has been fixture for avid investors for decades. In his latest letter, Buffett is reticent on many key topics, but his actions rather than words are sending clear signals to investors.

Latest Updates

Investing

Designing a life, with money to spare

Are you living your life by default or by design? It strikes me that many people are doing the former and living according to others’ expectations of them, leading to poor choices including with their finances.

Investment strategies

A closer look at defensive assets for turbulent times

After the recent market slump, it's a good time to brush up on the defensive asset classes – what they are, why hold them, and how they can both deliver on your goals and increase the reliability of your desired outcomes.

Financial planning

Are lifetime income streams the answer or just the easy way out?

Lately, there's been a push by Government for lifetime income streams as a solution to retirement income challenges. We run the numbers on these products to see whether they deliver on what they promise.

Shares

Is it time to buy the Big Four banks?

The stellar run of the major ASX banks last year left many investors scratching their heads. After a recent share price pullback, has value emerged in these banks, or is it best to steer clear of them?

Investment strategies

The useful role that subordinated debt can play in your portfolio

If you’re struggling to replace the hybrid exposure in your portfolio, you’re not alone. Subordinated debt is an option, and here is a guide on what it is and how it can fit into your investment mix.

Shares

Europe is back and small caps there offer significant opportunities

Trump’s moves on tariffs, defence, and Ukraine, have awoken European Governments after a decade of lethargy. European small cap manager, Alantra Asset Management, says it could herald a new era for the continent.

Shares

Lessons from the rise and fall of founder-led companies

Founder-led companies often attract investors due to leaders' personal stakes and long-term vision. But founder presence alone does not guarantee success, and the challenge is to identify which ones will succeed in the long term.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.