Listed investment trusts are one of the smaller subsets of managed investment products listed on the Australian Securities Exchange, with less than a dozen products currently listed. However, LITs look like assuming a more prominent position following a recent listing and more in the pipeline.
The listing of the Evans & Partners Global Disruption Fund, the planned listing of the MCP Master Income Trust in October and the announcement of the initial public offering of the Magellan Global Trust later this year have cast the spotlight on LITs.
Morningstar has issued a paper exploring the similarities and differences between LITs and better known listed investment companies (LICs).
Both are listed entities where underlying assets are managed in a pooled vehicle by professional investment managers.
Both are “closed ended” funds, which is a big differentiator from unlisted funds. This means that once an initial number of shares or units have been created through an IPO, these can only be traded on the ASX between willing buyers and sellers.
As a result, LICs and LITs can trade at a premium or a discount to their net asset backing, depending on the level of liquidity and demand.
Managers of unlisted funds can create new units to meet demand and the units trade at their face value.
The key difference between LITs and LICs is the way income and capital gains are treated.
LIC managers treat the dividends and capital gains from underlying investments as income, contributing to the profit and loss statement. The LIC pays tax on its earnings and pays distributions to investors in the form of dividends, franked or unfranked.
LITs 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.
LICs can elect whether or not to pay dividends. One advantage of this is that they can smooth cashflows and pay a steady income stream to investors.
LIT income streams are more likely to be unpredictable, fluctuating with the fund manager’s trading activity.
To offset these fluctuations, LIT managers can pay distributions that are above the fund’s income level. It does this through a return of capital.
LICs are more constrained in their capacity to pay dividends, limited to paying out of retained earnings.
One advantage of the LIT structure is that investors may be eligible for a discounted capital gains tax concession for assets held longer than 12 months (companies are not eligible for this discount).