Listed investment companies (LICs) have been around for decades, offering easy diversified exposure for ASX investors. But, are they still relevant in a world of exchange-traded funds (ETF) investing?
Let’s take a look at the differences.
Listed investment companies
A listed investment company, or LIC, is a publicly listed company that invests in other companies and assets.
It’s similar to a managed fund, except you can buy shares on the open market (like the ASX) just like you would buy shares in a company like Woolworths Group Ltd (ASX: WOW).
When you buy shares in a LIC, like Magellan High Conviction Trust (ASX: MHHT) or WAM Capital Ltd (ASX: WAM), you get exposure to all of the assets held by those companies.
For example, MHHT holds a relatively concentrated portfolio of 10 to 20 companies it believes are of outstanding quality. This currently includes a lot of the big US tech giants like Amazon.com Inc (NASDAQ: AMZN) and Microsoft Corporation (NASDAQ: MSFT).
A key feature of LICs is that they are closed-ended funds. This means, unlike a managed fund or an ETF, there are a fixed number of shares in the company. Keep this in mind for later.
But first…
Exchange traded funds
ETFs are a slightly newer investment vehicle, having first appeared on the ASX 20-odd years ago.
Like a LIC, when you buy an ETF, you’re really buying a portfolio of assets rather than just one company. ETFs often hold shares, bonds, property, or other assets.
However, they’re set up as a trust rather than as a company. This means you buy ‘units’ instead of ‘shares’.
They’re often passive funds, meaning they seek to track the performance of an index, like the ASX 200, rather than outperforming against it.
Common ETFs you may have heard of include the Vanguard Australian Shares Index ETF (ASX: VAS) and the iShares S&P 500 ETF (ASX: IVV).
So, what’s the difference?
There are a few key differences between a LIC and an ETF.
First, remember what we said about a LIC being a closed-ended fund?
This becomes important when we start to look at how the share price moves. When you invest in an ETF, new units are created and allocated to you, and your investment is spread amongst the underlying assets.
As the prices of the underlying assets move, the unit price of the ETF will move with them (minus any fees, spreads, etc.). So, if the ETF manager is doing their job, the change in price of the ETF will closely mirror the change in the underlying index.
In other words, you’ve got quite a direct exposure to the underlying holdings. Your return should be very similar to what it would be if you held all those shares individually.
A LIC, however, is closed-ended. That means when you buy shares, no new units are created. You have to wait for someone to sell you their shares.
That means that the price of the LIC can move up and down regardless of what the underlying shares are doing. In practice, this means that the market capitalisation of the LIC (its total valuation) can differ from its net asset value.
Remember, the net asset value is the sum of the value of all the underlying holdings.
So, LICs will often trade at a slight discount or premium to their net asset value. Some investors see this as a positive as it means you can get a ‘discount’ on the underlying assets. But there’s no guarantee that the share price will ever catch up to the NAV.
What it really means is that LIC pricing can be impacted by investor sentiment and market cycles independently from its underlying holdings. It’s an extra factor driving the share price.
In this way, ETFs offer a more direct exposure to the underlying assets than a LIC. Over time, you would expect the ETF to more closely track the underlying index.
Other important differences
To generalise, here are some other key differences:
- ETFs are often passive, while LICs are often active (but there are heaps of exceptions to this)
- LICs tend to charge higher fees (and often target higher returns)
- ETFs can be more transparent – ETFs have to disclose their underlying holdings, but LICs don’t (many still do)
- ETFs are generally more liquid. LICs need a buyer and a seller, whereas ETFs can create new units to manage liquidity
So, why would you invest in LICs when there are so many good ETFs available now?
Well, many investors have moved away from LICs as cheaper and more passive options have surfaced. In a lot of cases, ETFs are the better option.
But they could still make sense in certain scenarios.
For example, when a sell-off has occurred, LICs can trade at a big discount to their NAV which could present an opportunity to buy a portfolio of great companies at a low price.
They can also make sense in sectors where active management is likely to outperform passive. For example, small-cap shares and emerging markets. These are two areas where active fund managers can often still have an advantage over passive funds.
So, should you buy a LIC or an ETF? It really depends.
If you understand the pros and cons of each and you know what your goals are, you’ll be able to work out which works best for you.
If you want to learn more about ETF investing, check out our free ETF investing course.
