When we think about the local share market, it’s usually companies that come to mind.
The chance to add part of an up-and-coming tech developer, an innovative biotech or a blue-chip retailer to your portfolio can be an exciting prospect.
But what if you were able to up your exposure to a whole range of stocks with just one investment?
In this article:
- What is an ETF?
- What is an LIC?
- What's the difference?
- Pros and cons
- How can an ETF or LIC bolster your portfolio?
That’s where exchange traded funds (ETFs) and listed investment companies (LICs) come in.
Both products are listed on the share market — just like a company is — but they broaden your horizons with an investment into an amalgamation of stocks.
The question is: what’s the difference between the two?
Hold up — what’s an ETF?
To define exactly what these investments look like, we turned to the team at financial advisory and accounting firm Findex Wealth Management.
Managing partner of wealth management Jonathan Scholes explained just how these funds operate to Proactive.
“An exchange traded fund is an open-ended issuance of shares that would typically invest in a portfolio that passively tracks a specific benchmark or index,” he said.
“An ETF is a trust and must distribute all dividends through to shareholders, and must also disclose their investment holdings on a daily basis.”
And an LIC?
Scholes has an answer for that too.
He noted: “A listed investment company is typically a close-ended issuance of shares and is an actively managed portfolio of stocks, with generally a qualitative and/or quantitative investment approach.
“A LIC will pay a dividend at their discretion and only needs to report their holdings on a monthly or quarterly basis.”
What’s the difference?
There are a few differences at play when it comes to these investments — things like cost, transparency and management styles all vary.
Scholes explained: “The main difference between an ETF and LIC is the structure, in that an ETF is a trust while an LIC is a company.”
Often we refer to an ETF as an open-ended structure — that means an unlimited number of shares can be issued and it can always support market demand.
An LIC, on the other hand, is close-ended — there are a limited number of shares available and managers need to raise capital in order to issue more shares — just like a company would.
“The other major differences are around the philosophy of a passive approach for an ETF, as opposed to an active approach for a LIC,” Scholes noted.
While an exchange traded fund serves to mirror the trading pattern in a certain index — be it the benchmark ASX 200 or the All Ordinaries — a listed investment company has people behind it who actively pick which stocks to follow.
That’s where the higher costs come in.
“You should also expect that a listed investment company will have higher fees than an exchange traded fund, given the active management.
“By choosing to invest in a LIC, you are essentially backing that manager to deliver a higher return after fees than what a passive, index-style ETF will deliver.”
Transparency also differs between the two investment structures.
Because it’s following a particular group of stocks, an ETF regularly discloses something called a net asset value (NAV).
An LIC also reports this information, but their holdings and weightings aren’t always disclosed, so it can be a little less frequent.
Simply put, the NAV serves as a barometer to the investment vehicle’s performance — it’s just the total assets on hand minus the liabilities.
“It is important to note that with an ETF, the share price will typically match the net asset value of the stocks very closely, whereas with a LIC it can deviate quite heavily.
Pros and cons
Whichever investment you opt for can be impacted by your appetite for risk.
Because it follows an index pretty closely, is more transparent and is open-ended, an ETF often involves less investment risk.
You also get lower fees with ETFs, owing to the passive management.
And as an asset class, ETFs are statistically more likely to perform better than their LIC counterparts, thanks to the simpler fee structure.
On the other hand, an LIC has the potential to break free of those market patterns and really shine.
But with this opportunity comes some higher risks — and costs like stamping fees to cover the recommendations from the active management team.
Ultimately, it’s best to decide what investment vehicle is right for you with the help of a broker.
How can an ETF or LIC bolster your portfolio?
Scholes concluded: “Investing in an ETF or a LIC is an easy way for investors to get access to a diversified portfolio with many different shares. This approach reduces the risk of one bad investment impacting your performance.
“The barriers to entry are generally small, with no minimum investment, no large entry fees and easy access to your money when you need it. This means you can start out small and build up over time.
“Understand what you are investing in and do your research on how the underlying investment has performed in both good markets and not so good markets.”