Shareholder Activism in Listed Investment Companies

In this article published in The West Australian on 14 November 2016, David Alder discusses shareholder activism in Listed Investment Companies.

Take time to analyse LIC option

Listed Investment Companies (LICs) are increasingly popular investment vehicles in Australia, with more than 30 listed on the Australian Securities Exchange since 2012. This takes the total number to more than 85 and funds under management in excess of $30 billion.

While LICs might look like a good idea on the surface it’s a case of investor beware, with many externally managed LICs performing poorly through investment performance, inadequate marketing and communications to prospective and existing shareholders, unreasonably high fees, no track record of paying fully franked dividends, and undertaking capital management which favours the Investment Manager over the shareholder.

Like other companies that are listed on the ASX, LICs are overseen by a board of Directors and day-to-day activities are taken care of by professional Investment Managers.

Many newly incorporated LICs tend to be small in size (with limited liquidity), are yet to establish consistent investment track records, and have external Investment Management Agreements (IMAs).

Under these IMAs the investment manager is an external entity (usually a distinctly separate company but often associated with the LIC) that has been appointed to manage the company’s affairs under a legally binding contract with terms that are fixed, lengthy, and have automatic extension. Not surprisingly often some of the Directors of the LIC are also employees or owners of the Investment Manager (read into this what you will) and own very few shares in the LIC. Many of these LICs are trading at a discount to net tangible assets (NTA), which means shareholders that need to sell their shares may be doing so for, say 85c in the dollar.

Imagine signing an agreement to commit yourself to a financial adviser or fund manager for 10 years in advance, regardless of their performance. This is what many LIC investors are effectively doing.

In a recent high profile case, AMP Capital China Growth Fund was forced to wind-up its portfolio of Chinese-listed shares and return capital to its shareholders after its underlying portfolio had consistently underperformed, and its share price was trading at a discount to NTA of over 35 per cent. A handful of fund managers called an extraordinary general meeting and agitated for the wind-up.

Other examples of very ordinary capital management decisions which can be made by LIC boards include undertaking share placements or rights issues at large discounts to NTA, thereby either placing stock to new investors at the expense of existing, or forcing existing shareholders to fork out more cash to participate or risk their interest being diluted. Issuing more shares arguably benefits the investment manager (external company) by increasing the pool of funds being managed, thereby increasing the fees being generated. In our experience these capital raisings are normally done when markets are frothy and valuations are full as companies try to take advantage of investor enthusiasm. As the investment manager feels obliged to deploy the funds raised (rather than sit on the cash) they invariably time their entry to the market badly and further exacerbate the downside for investors.

Fortunately, the Corporations Act provides LIC shareholders with rights to influence the composition of the board as well as general meeting agendas. Broadly, a shareholder (or a group of shareholders) holding more than 5 per cent of the issued capital of a company has the ability to:

  • Call for a general (or extraordinary) meeting.
  • Propose shareholders’ resolutions to be considered at a meeting, for example to remove a director or directors to nominate a director or directors, to terminate the IMA and replace the Manager.
  • To wind up the company and return capital to shareholders.
  • To propose a capital management initiative, such as undertake a share buyback, pay a special dividend, or implement a dividend policy.
  • Require the company to distribute a shareholder statement to all shareholders (from the activist) of no more than 1,000 words which can be extremely influential.

Furthermore, under a 2011 amendment to the Corporations Act, if any company’s, including an LIC, remuneration report is voted down twice, a full board spill (where all Directors will need to stand for re-election) can be triggered upon receiving a second ‘strike’. The threshold is set at just 25 per cent, therefore a strike can ensue in a situation where only 25 per cent of shareholders that actually vote, vote against the remuneration report.

Whilst there are other issues associated with LICs that have not been highlighted in this article, in our view Australia’s shareholder-friendly regulatory framework provides some protection over investing in unlisted managed funds where the rights of unit-holders can be limited almost entirely to redemption (which can trigger capital gains tax for certain investors).

Shareholder activism is growing rapidly in Australia largely via institutional investors. Whilst retail investors are the major shareholders in LICs they are learning how to protect their rights and can join forces with other shareholders to hold boards and investment managers to account without fear of reputational damage (which most institutions have when taking an activist approach). A good place to start would be to review the top 20 shareholders in the annual report or to ask your financial adviser what they are prepared to do to assist.

Some of the tactics used by boards and investment managers to protect their interests, including buying a blocking stake of shares in the LIC, is a topic for another day.