controversy rages, page-10

The document has very few accurate observations and of those observations none appear to be brought to well measured logical conclusion.

The only semi-valid point I see is on cross ownership but his conclusion is mostly rubbish. Cross ownership is potentially detrimental to shareholders and potentially beneficial to Directors. I'll give a long winded explanation of my point of view.

Scenario:
LIC A: Has 100mill NTA. 0.2% MER. 10% is invested in LIC B.
LIC B: Has 100mill NTA. 0.2% MER. 10% is invested in LIC A.
Shareholder A: Has $10k invested in LIC A.

1) Potentially detrimental to shareholders.

Shareholder A cops LIC A's expenses each year for the portion of that LIC he owns. This equals his current invested capital value multiplied by the LICs MER (for this scenario $10k * 0.2% = $20). He also cops LIC B's expenses each year for the portion of that LIC he owns via LIC A ($10k * 10% * 0.2% = $2). There is some 'double dipping' on fees for the shareholder.

This needs to be kept in perspective. Firstly it is a fractional increase. In the vast majority of real cases that I'm aware of this still leaves the lower MER LIC's with much lower true effective MER after cross ownership compared to almost all funds. Secondly it is clearly possible that another LICs share price may offer an attractive investment opportunity that outweighs this negative effect. The goal of LIC management should always be towards overall benefit to their current shareholders. Thirdly, an investor that is not a current investor at the time of cross-ownership purchase may have missed out on this possible value creation and may only be buying into the remaining effects which should be an unrealised capital gain that remains due to the undesirability of realising the tax and also an ongoing double-dipped management expense cost. This is not a problem however because the shareholder has the choice to buy or not at this time based on a price that is determined by market forces and will (market efficiency issues aside) already have factored in these issues along with many others.

Point 2) Potentially beneficial to Directors

It is fairly easy to assume that the 'double dipping' expense effect described in point 1 is directly to the benefit of the Directors. It isn't really true - there is no direct benefit. There is only indirectly beneficial due to market inefficiency.

For each share of LIC B sold by LIC A there is another buyer of that share. There is no effect whatsoever on LIC B's invested capital (Its underlying capital is not even part of the transaction). For LIC A they receive cash for the sold share which they can invest elsewhere which, ignoring potential market liquidity issues and buy/sell spreads, also results in no net change. This means if LIC A and LIC B could divest their cross ownership right now and assuming no liquidity/spread issues would both end up with the same $100million capital at 0.2% MER. No direct effect.

The 'problem' is only that the demand for those shares may not exist. If two LICs cooperate in cross ownership trades they create capital without demand. How big this problem is just depends on how efficient the market is. If LIC A and LIC B both had 50% cross ownership at MER of 0.2%, it is no different to having zero cross ownership at half the asset base (the same real underlying assets) and dobule the MER (0.4%). If the market was efficient it would treat these 2 cases exactly the same and their would be no net benefit for the LIC Managers.

I think the realities are..
a) The market is somewhat inefficient.
b) LIC managers probably do see benefit from cross ownership through market inefficiency however cross ownership is not currently all that significant and the market is fairly efficient so the overall benefit wouldn't be much.
c) ASIC would be on the case if this was taken to greater extremes.
d) Individual shareholders are only really effected by this to the extent that it's inefficient - and even then the scale dictates its far less detrimental to the average small shareholder than it is beneficial to the more concentrated group of managers.
e) All companies are somewhat 'dodgy' in ways like this, in the end on average it only suppresses our shareholder return by the amount we as a whole allow it to do so through the pricing the assets and beyond this the performance of an individual above or below this accepted level is dictated by their own ability to price assets more or less efficiently than the market.