ETF vs LIC Market Growth
A Listed Investment Company (LIC) is an actively managed fund in a closed ended structure that is listed on a stock exchange.
The ETF industry surpassed the LIC market for the first time in September 2018. What is even more remarkable is the first LIC was launched 65 years before the first ETF was launched in 2001.
That’s right, the LIC is 82 years old and the ETF beat it at just the tender age of 18! Since 2010, LICs have grown at 9% p.a. vs ETFs at 29% p.a.
ETFs (represented by the dark blue line) taking the lead over LICs (represented by the light blue line) in market size (FUM)
What are the differences between ETFs and LICs
Even though both ETFs and LICs manage collective pools of money and trade on the ASX, there are some important differences which investors need to be aware of.
|Investment Style||Passive – aiming to mimic a market like the top companies on the ASX 200 index (S&P ASX/200)||Active – aiming to outperform a benchmark|
|Cost||Low – the weighted average index ETF fee is 0.26%||Higher than ETFs and many charge performance fees. The weighted average fee is 0.59% – more than double an ETF|
|Diversification||ETFs track an underlying index (i.e. the market) which invests up to thousands of different securities and companies, meaning better diversification||LICs typically have less holdings than an ETF (i.e. stock selection rather than owning the market) so does not benefit from broad diversification|
|Structure||Open ended – units are able to be created or redeemed based on investor demand||Closed Ended – there are a fixed number of units outstanding, and are unable to issue or redeem more shares to respond to investor demand|
|Dividends/distributions||Earnings must be distributed to shareholders||Not compulsory to distribute earnings. Dividends are distributed only when the manager chooses and the board declares it|
|Price and Net Asset Value (NAV)||Price of the ETF trades very close to NAV||Price can vary from NAV – can trade at discount/premium|
|Transparency||Daily basket of underlying holdings. An Indicative Net Asset Value (iNAV) is also produced every 15 seconds which shows the value of the underlying holdings||Delays in disclosing holdings. NAV only required to be announced on a monthly basis|
|Tax Efficiency||Lower turnover – meaning less capital gains tax (CGT) events||Higher turnover – meaning more CGT events|
|Legal structure||ETFs are a Trust: it does not pay tax on earnings, but passes these to investors who pay tax at their marginal tax rate. i.e. distributed pre-tax returns. Investors own units in the trust.||LICs are a Company: subject to the 30% company tax rate on income and realised capital gains which they can hold onto or pay out to investors, who are then liable for tax at their marginal tax rate (plus any franking benefits). Investors own shares in the company.|
Why ETFs are winning
ETFs have low portfolio turnover (i.e. trade less frequently) as they track an index, that is rebalanced periodically rather than actively buying and selling stocks regularly. The frequent trading by LICs means investors will pay more in CGT.
For ETFs, the CGT implications are limited through the ETF creation and redemption process. Blackrock found that only 6% of ETFs paid a CGT event, compared to the 59% from an actively managed fund.1
Trading at Discounts/Premiums To Net Asset Value (NAV)
LICs often trade at a discount to the value of the investments inside of them. For example if the investments inside a LIC are worth $1, a typical LIC would trade on the ASX at $0.96. This means investors in LICs never really get what they pay for and they rely on other investors buying off them when they decide to sell.
When markets are volatile LICs can trade at even bigger discounts to their real NAV which makes them risky to invest in. On the other hand ETFs, due to the unit ‘creation and redemption’ process almost always trade at very very close to their true value. This gives investors in them more confidence that they will be able to sell at a fair price.
Paying for underperformance
LICs are traditionally active managers who consistently underperform their benchmarks across all asset classes. For example, the average Australian Shares (Broad) ETF outperformed the average LIC in the same asset category by over 2% p.a. over 5 years.2 LICs also charge higher fees (more than double the ETF), with many including performance fees.
At Stockspot we avoid LICs and rather use a portfolio of low cost diversified ETFs.
LICs were exempted from Future of Financial Advice (FOFA) reforms in 2012 which banned trailing commissions on certain financial products like ETFs and Managed Funds. We believe that LICs should be included in this legislation to avoid conflicted remuneration.
When a new LIC comes to the market, the LIC may pay commissions to financial advisers and brokers to push their products to sell to their clients.
One of Australia’s active fund managers, Christopher Joye, has claimed that the wave of LICs launched since 2017 have paid more than $150m in conflicted remuneration to advisers/brokers.3
Lack of Transaprency
Investors may have no idea what they are buying as not all LICs have same day disclosure of the underlying holdings than an ETF does. When you invest in something, you should know exactly what you are holding the day you commit your money.
Find out how Stockspot makes it easy to grow your wealth and invest in your future.
1 iShares ETF Myth Busting 2018
2 ASX March 2019 Data
3 Australian Financial Review (AFR) – ‘Boiler rooms’ are back as listed investment companies raise $6b (March 2019)