At AFIC, our investment style is to buy shares in listed companies and hold them for the medium to long-term. This approach minimises dealing costs and has historically provided investors with sound, tax-efficient, long term returns.

As a listed investment company, there are countless terms and acronyms that can be confusing to investors – both new and old.

Whether you’re a first-time investor or a veteran of the ASX, it’s important to understand the key terms and how they relate to your portfolio. We’ve developed a short guide to some of the most common terms.

Share Price premium or discount to Net Asset Backing (NTA)

Investors in LICs often talk about shares trading at a 'discount' or 'premium' to NTA. The Share Price is the current price of an AFIC share listed on the ASX. Net Tangible Assets per share (NTA) is the value of the total portfolio divided by the number of shares on issue.

If the share price is higher than the NTA, it is considered to be trading at a premium. Conversely if the share price is trading below the NTA the share price is considered to be trading at a discount. There are a few reasons this can occur, including investors’ perception of risk in the market and the demand or otherwise for dividends.

Fully franked dividends

As a long-term investor, one of our methods of communicating value to our shareholders is through a growing stream of fully franked dividends. Many companies listed on the ASX pay a tax rate close to 30 per cent on profits, and a dividend is paid to shareholders from after-tax profits. This means shareholders are entitled to a credit for tax the company had already paid – otherwise known as franking credits.

Capital gains tax and LIC Credits

Tax can be a significant drain on the returns to investors. The long-term buy-and-hold approach adopted by AFIC typically results in a low level of capital gains tax payable because few positions are sold each year. Where AFIC does realise a capital gain, we aim to pass on any LIC credits generated by these capital gains as part of the dividend, thereby providing the opportunity for shareholders to potentially claim a tax deduction.

Management expense ratio

A management expense ratio (MER) measures how much the cost of running the fund (administrative and other operating expenses) relates to the total size of the portfolio under management. An expense ratio is determined by dividing a fund's operating expenses by the average dollar value of its assets under management over the year. One of the main reasons to consider investing in AFIC is our very low MER of 0.13 per cent. Over the long term, a low MER can make a large difference to overall returns.

Dividend Reinvestment Plan (DRP)

The DRP is an easy way to accumulate more shares over time by reinvesting your dividends in additional shares. Participants enjoy the benefits of compound returns over time with no brokerage costs when acquiring additional shares. It’s entirely flexible, allowing you to join or withdraw at any time.

Under a DRP, the Australian Taxation Office requires that the investor declares the dividend to acquire extra shares as income, and the investor must pay tax on it. The investor still receives franking credits to offset the tax and can continue to obtain a tax deduction relating to LIC capital gains.

For more information on the DRP, please read the DRP Rules.

Dividend Substitution Share Plan (DSSP)

The DSSP is another way to accumulate shares over time. The main difference from the DRP is that no income tax is payable at the time of receipt of the dividend. Also, because the shares allotted under the DSSP are not considered to be a dividend, the investor does not receive franking credits or LIC capital gains tax deductions.

The DSSP could be a good option for shareholders paying tax in Australia who want to defer any tax payable until they sell their AFIC shares. The DSSP also may be suitable for shareholders on a high marginal income tax rate.

For more information on the DSSP, please read the DSSP Rules.

It’s important that shareholders in all cases seek their own advice from their accountants and tax advisers on whether or not participation in the DRP or DSSP is appropriate for them.

Nursery stocks

We aim to maintain a ‘nursery’ of smaller stocks in the portfolio and therefore remain constantly on the lookout for new companies that have the capacity to develop into major businesses over time. While such companies may be small, they typically exhibit similar characteristics to those in the core investment portfolio and provide AFIC with future growth options.

If you want to learn more, read more about AFIC and our investment approach.