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How do you pick your stocks?

With the stock market making monkeys out of experts and the new valuations for popular shares making many comment that good buying opportunities are emerging, the question is do you do your own stock picking or do you rely on the experts?
Those toying with the abdication option predicably could be thinking about a managed fund while others might be thinking about a listed investment company (LIC).
I dare say the numbers for the latter would be smaller with a number of advisers admitting to me that they have more confidence with funds.
One of the big reasons for the relative comfort with funds is that they are regularly evaluated by the ratings businesses such as Lonsec.
However, Lonsec, which many advisers use, doesn’t pass judgements on LICs and so a potential rival to investment funds is a bit of an orphan to the advisor community.
In case you didn’t know, ASIC’s rules on financial planners mean these advisory businesses have to have an approved product list which is formally identified and reasons are made for supporting these investments. (When clients want to create a self-managed super fund, the stocks in the portfolio have to be researched and a judgement has to be passed.)
Stockbrokers do put buy or sell recommendations on LICs such as Argo Investments, Century Australia and Australian Foundation Investments.
The task of making a call between an investment fund and a LIC becomes a bit harder when they are seen as rivals but the official adjudicators don’t apply similar tests to both investment products.
The ASX website defines LICs as vehicles that “provide exposure to a diversified portfolio of investments on behalf of their investors.”
Typically these investments may include Australian shares, international shares, private equity and specialist sectors such as wine and resources.
They tend to be in four main areas: Australian shares, international shares, private equity or specialist assets or investment sectors.
This can include everything from wineries, technology companies, resources and telecommunications.
For a bit of history, the ASX says investment companies are one of the oldest forms of managed investments with the first one on the exchange dates back to 1928.
Like funds, investment techniques can differ substantially with LICs while the investment approach can range from very conservative to aggressive. And just with funds the recommendation from experts is to match your appetite for risk to that of the LIC.
Doing homework is vital with LICs so you understand the main bent of the company.
“Many LICs manage the investment portfolio to minimise tax and produce regular income through fully franked dividends,” the ASX website advises. “These techniques assist in providing investors with stable returns.”
Where a fund gives investors units, LICs are valued via shares.
Investment funds pay out all surplus income in the form of distributions, which will reflect tax credits, dividends, etc. On the other hand, LICs are likely to pay fully franked dividends determined by the company’s management.
The ASX says there are four reasons why you might want to try a LIC:
  • you get a diversified portfolio through a single investment
  • you might want returns from both capital appreciation and income
  • you’re looking for a tax managed investment with relative consistency in returns
  • you want a concentrated exposure to a specific investment sector.
There are more appeal factors. First you can have more of say with a LIC as it has a annual general meeting.
Second, the management expense ratio (MER) is often lower mainly because they don’t pay advisers kickbacks. Though they can have performance fees.
Third, while managed funds have to meet redemptions of units and this can affect the returns on the portfolio, the LIC can be fully invested and the shareholders simply sell their shares to someone else when they want to cash out.
A big negative with LICs is relevant in the current setting. While a fund’s value will reflect the underlying investment’s performance and value, the LIC can be a victim of market forces.
That means they can be trashed by Wall Street panics, short-sellers and hedge fund shenanigans.
Looking for rules of engagement, the experts say opt for LICs where the net tangible assets (NTA) outweigh the share price. It’s called buying at a discount. The NTA is like a funds under management measure.
Clare Aitchison, analyst at the respected investment ratings outfit, Aegis, says some LICs are currently trading at a big discount to its share price, which generally means they’re good to go.
“AFI has been trading at a small discount because it has been around a long time and attracts the risk-averse,” she said.
On a pre-tax NTA basis that includes dividends AFI has a pretty good track record. For one-year to December it came up with 16.6 per cent. On three-years it was 19.2 per cent and for five-years it was 19.8 per cent.
Of course the March quarter figures are the show and tell numbers we want to see with the stock market in nosedive mode. Aegis publishes these six-eight weeks after the quarter.
For your information, they are commissioned by the fund but Aitchison says they are completed by independent assessors. They are free on the Aegis website.
Another well-known LIC is Argo Investments and its track record hasn’t been bad. For 2007 it was 11.5 per cent after a tough December quarter. Over three-years it returned 16.8 per cent and 19.3 per cent over five-years.
At the same time the All Ords Accumulation Index did 18 per cent, 21.3 per cent and 21.4 per cent over the one-, three- and five-year time frames.
To get an idea of what Argo Investments gets involved in Aitchison summed up its portfolio.
“As of December, its top 10 stocks made up 40 per cent of its portfolio,” she said. “And they represented 28 per cent of the all ordinaries Index.”

Anyone wanting to start watching the NTAs to compare the share prices can check out the ASX website on the 15th of the month. 

Published on: Thursday, March 13, 2008

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