LIC vs Managed Fund: How Structure Shapes Your Exit

A listed investment company can trade below the value of its assets for years at a time while the portfolio underneath keeps compounding. An unlisted managed fund prices units from the value of its portfolio each time investors enter or exit. That structural difference sits at the core of the LIC vs managed fund decision, and it matters most at the point an investor needs to sell.

Unit creation ties a managed fund’s price to its portfolio

A managed fund issues new units when money comes in and cancels units when money leaves. Each transaction is priced from the net asset value (NAV) calculated on that day, adjusted by a buy/sell spread that covers the cost of trading the underlying holdings. Entry and exit prices therefore move with the portfolio.

A fixed share count lets an LIC’s price drift from its assets

An LIC raises capital once and then manages a fixed pool. Its shares trade on the ASX between investors, so the price reflects what a buyer will pay on the day. Demand for the shares, sentiment towards listed vehicles and the interest rate backdrop all feed into that price alongside the value of the portfolio. This is why an LIC can trade at a persistent discount or premium to its net tangible assets (NTA).

Take an LIC with NTA of $1.00 per share trading at a 13 percent discount. A shareholder who sells receives about 87 cents for every dollar of underlying assets. If the portfolio then rises 10 percent while the discount widens to 20 percent, NTA moves to $1.10 but the share price only reaches 88 cents. The portfolio has gained and the shareholder has barely moved.

Discounts tend to widen when investors most need to sell

In stable markets, both structures offer a reliable exit. Under stress, the mechanisms diverge. LIC discounts respond to sentiment and interest rates as well as to portfolio value. When rates rise, income investors can find yield in cash and bonds, demand for LIC shares weakens, and discounts can widen even while the portfolio holds its value. An investor forced to sell at that point absorbs two separate losses: any fall in the portfolio and any widening of the discount.

Redemption terms set the limits of an unlisted fund’s liquidity

A managed fund investor redeeming in the same conditions receives NAV, less the sell spread, with no market discount layered on top. The fund carries its own liquidity risk instead. A managed fund meets redemptions by selling assets, and its constitution sets how often investors can redeem, how long payment can take and when withdrawals can be suspended. In late 2008, a number of Australian unlisted mortgage and property funds froze redemptions because their assets could not be sold quickly enough to meet withdrawal requests. Funds holding listed equities face this risk to a lesser degree because their holdings trade daily, although smaller, less liquid stocks can take longer to sell in volume.

The LIC structure has a matching strength. Because its capital is fixed, an LIC manager never has to sell holdings to fund an investor’s exit, and can hold or add to positions through a downturn without regard to investor flows.

Three questions decide which structure fits

• How likely is it that the position will need to be sold at short notice? The higher that likelihood, the more discount risk matters.
• How long is the money invested for? A holder with no near-term need to sell can wait for a discount to narrow, although there is no guarantee it will.
• How comfortable is the investor with share price and portfolio value moving apart? That gap can persist for longer than intuition suggests.

None of these questions has a universal answer. Each depends on what the money is for.

Portfolio relevance

Structure sits upstream of manager selection. Before assessing whether a manager’s process suits a portfolio, investors benefit from understanding how the vehicle used to access that manager behaves on exit under stress. Datt Capital’s funds are unlisted managed funds. Unit prices are calculated from the value of the underlying portfolio, with a buy/sell spread applied, and redemptions are governed by the terms set out in each fund’s Product Disclosure Statement. That structure is one input among several when choosing a manager, a process outlined in our guide to choosing the right fund manager in Australia.

Conclusion

Structure determines how an investment behaves at the point of exit as well as while it is held. An LIC’s share price can sit well below its underlying value for extended periods, particularly under stress. A managed fund’s unit price follows NAV, while its liquidity depends on redemption terms and how readily its assets trade. Neither structure is inherently superior. The right choice depends on liquidity needs, time horizon and tolerance for a gap between price and value.

To learn more about how Datt Capital’s funds are structured, visit our funds page or contact our Distribution Manager, Daniel Liptak, at 0419 004 524 or by email at daniel@datt.com.au.