Transparent and efficient

The big listed investment companies (LICs) have always been attractive to cautious investors. Their conservative approach and preference for blue-chip stocks has helped protect them from the worst of the sharemarket falls.

LICs aim to outperform the returns of the market in which they invest. The big three LICs - Australian Foundation Investment Company (AFIC), Argo Investments and Milton Corporation - invest in Australian shares and securities.

During the sharemarket boom, many new LICs were listed in Australia. Some invest with particular investment themes, such as commodities, real estate and infrastructure.

While some of the new LICs have performed poorly, the larger LICs, such as Argo Investments and AFIC, have performed relatively well during the downturn. They are a cheap way of buying instant diversification into Australian shares.

Argo, for example, costs investors just 0.12 per cent a year as a percentage of the value of Argo's share portfolio. Retail managed funds, the unit trusts favoured by financial planners, have fees of up to 2 per cent, though about 0.5 of a percent will be the financial adviser's fee.

Over the 10 years to November 30 last year, Argo's total average annual shareholder return (including dividends) was 9.8 per cent. The return of Australian shares, as given by the All Ordinaries Accumulation index, was 7.3 per cent.

Argo holds about 160 companies but more than half of the portfolio is in about 20 stocks, most of which are the sharemarket's biggest stocks.

"I love them," says Colin Cruickshank, a private client adviser with Baillieu Polkinghorne.

He particularly likes Argo and AFIC. He says they have straightforward investment processes. That stands in stark contrast to the too-clever-by-half managed investments that have come unstuck as a result of the global financial crisis.

"If my clients ask me what they should be buying for their grandchildren I say Argo or AFIC," Cruickshank says. He warns, however, that investors should not just blindly buy shares in LICs.

They need to check how the share price is trading with respect to the value of the LIC's portfolio.

The share price of the LIC is influenced by the demand for the shares. That means the share price can get out of alignment with the value of the investment portfolio, or net tangible assets (NTA).

In booming markets, the LIC's share price often moves below the value of the portfolio, on a per share basis. That is because, during boom times, investors prefer riskier and potentially higher-returning investments. But when markets retreat investors return to conservatively managed investments, such as the big LICs and their portfolio of dividend-paying stocks.

In a research note on the LIC sector released in December, Goldman Sachs JB Were said Argo's share price had moved to a pretax premium to its NTA of almost 13 per cent.

Because of the size of the premium of share price to NTA, Goldman Sachs JB Were gave Argo a "hold" recommendation while AFIC, whose shares were trading at a small pre-tax premium of just over 3 per cent, received a "buy" recommendation.

"It is important to buy them when the shares are trading at about 'par' or at a discount to NTA," Cruickshank says. That is why advice from a stockbroker is considered important before buying shares in LICs.

Of course, for those investors in LICs who add regularly to their shareholding in the LIC, the share price should equal the value of the portfolio over time.

Some LICs have dividend re-investment plans and some allow shareholders to top up their shareholding at a discount to the market price. Argo, for instance, allows shareholders to buy $2500 worth of shares, at a discount to market prices, each six months.

No brokerage or other transaction costs are payable by shareholders.

HEALTHY SCEPTICISM PAYS DIVIDENDS

ROB PATTERSON is only the second managing director in Argo Investment's 63-year history.

The company has more than 60,000 investors and, with a portfolio of about $3 billion, is one of the biggest 100 companies listed on the Australian sharemarket. The other listed investment company heavyweight, Australian Foundation Investment Company, has more than $3.5 billion in assets and an 80-year history.

As everybody knows, it has been a tough 12 months for investors. Australian share prices fell by more than 40 per cent during 2008.

"Certainly the market fall is the worst that I have ever experienced," Patterson says from his Adelaide office. All of his 40 years in the market have been at Argo, the last 2 1/2 decades as managing director.

As the boom reached its crescendo in 2007, Argo increased its cash holdings as it found it harder to justify the prices of shares in many of its favoured companies. Patterson says there is always a temptation to get caught up in the euphoria of a market boom but "we try to resist getting dragged into it".

Argo carries no debt and sticks, in the main, to investing in solid dividend-paying companies.

That helps in market falls "but you do get affected to an extent because you can pay too much for blue chip shares", Patterson says.