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Experts
Ever wondered what the difference is between an Exchange Traded Fund (ETF) and Listed Invested Company (LIC)?
Global X ETFs head of distribution Kanish Chugh said the LIC market in Australia was once very popular but is “slowly dwindling”.
“The number of LICs which have launched in recent years has not been very high,” Chugh said.
At end of December 2021 there were 99 LICs listed on the ASX and by the end of December 2022 there were 92 listed.
In 2022 only one new LIC listed on the Aussie bourse – the H&G High Conviction Limited (ASX:HCF).
Chugh said at the end of September 2018 the ETF market surpassed the LIC market in Australia in terms of Assets Under Management (AUM).
“The ETF industry was roughly $42.3 billion and the LIC industry was $42.23 AUM and that was the first time we saw the ETF market growth surpass the LIC market,” he said.
“When you look at the end of January 2023 the LIC market is $50.26 billion, and the ETF market was $135 billion and that is gap is only growing.”
Notwithstanding falling sharemarkets, Australia’s ETF industry has set a record high ending February with $139.7 billion in funds under management.
So, what are three big differences between an LIC and ETF?
Chugh said when you break out the acronym ETF it is simply a fund traded on an exchange.
He said the key difference from an ETF to a LIC is it is open-ended.
“As more investors buy the ETF that size of the ETF and number of units on issue will increase,” he said.
“If you have a lot of people buying the ETF the provider will create more units and if you have people selling that ETF then they may essentially redeem units.
“The number of units on offer will increase or decrease based on flows.”
Chugh said unlike an ETF an LIC is closed-ended.
“There is a specific number of units on issue similar to any company listed on an exchange,” he said.
“Therefore, the price of that LIC is determined by the buying and selling of investors.”
Chugh said LICs are generally active and don’t provide transparency on the underlying portfolio as frequently as an ETF.
“An ETF provides transparency every day where a LIC operates under different reporting guidelines,” he said.
“Depending on the manager some are happy to provide that underlying transparency while others are not.”
Chugh said whether a broad exposure or thematic, ETFs are mostly passive investments, tracking a benchmark index such as the S&P ASX 200.
“An ETF tends to track a benchmark so there’s transparency for an investor in what you are investing in and your exposure is there at the outset,” he said.
Chugh said because of being passive products and having transparency, ETFs tend to have lower fees.
“You will generally be paying less for an ETF than an LIC from a fee perspective, so it is more cost efficient,” he said.
Other key differences include:
Chugh said an ETF’s liquidity is based on the underlying exposure it is trying to track.
He said ETFs have a market-maker or a structure and a system and a process which is regulated that is set up to ensure there is always a market for investors to buy and sell.
“That is the job of regulatory bodies and ETF providers to ensure liquidity occurs,” he said.
“With an LIC the liquidity is based on buyers and sellers – if, for example, you don’t have someone wanting to buy, how do you exit your position and that is a big concern?”
Chugh said ETFs put taxable income in the hands of the unit holder and traditionally there could be less turnover of the underlying asset and lower realisation of capital gains.
“With an LIC that is an entity of a company that pays company tax on income before distributing dividends,” he said.
A LIC generally has higher realisation of capital gains each year because being actively managed means it tends to have a higher turnover than traditional ETFs.
Chugh said the net asset value is the true value of an underlying asset and because of that supply demand focus an LIC could trade at a premium or a discount.
“You may be paying $110 a unit when the unit actual value is $100 and conversely you could be paying $90 for a unit when the underlying true value is $100,” he said.
ETFs tend not to have the issue of high premiums or discounts due to their open-ended structure and the involvement of a market maker whose job is to accurately price the value of the ETF based on the value of the underlying exposure during market hours.
Chugh said an LIC is a bit of an outdated structure which fund managers would launch to raise assets.
“They would run an IPO-style process so go out to the market and say we’re looking to raise assets, there would be an IPO period and investors could nominate to invest in the fund,” he said.
“They would raise a certain amount of assets exactly like a stock that is listing.”
Chugh said the number of units is set until the fund managers decide to either raise more or keep it at the amount.
“From there on end the unit price is determined by supply and demand just like a stock,” he said.
“How does a stock price move? It’s determined by how many people want to buy and sell and what they are willing to buy and sell for.”
Chugh said many LICs are now converting to an ETF structure.
“There is this understanding now that ETFs as a structure were the disruptors to the market with managed funds and LICs being the outdated structure,” he said.
“ETFs have provided transparency on the portfolio, on what investors pay for, a more cost-efficient structure and greater choice.
“For a lot of fund managers when they are looking to bring a product out to market the ETF structure is generally seen as the more viable solution moving forward.”
NOW READ: How Aussie managed funds performed in 2022
The views, information, or opinions expressed in the interviews in this article are solely those of the interviewees and do not represent the views of Stockhead. Stockhead does not provide, endorse or otherwise assume responsibility for any financial product advice contained in this article
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