Comparing ETFs and LICs with Managed Funds

ETFs vs. Managed Funds

ETFs consists of a diversified portfolio of securities constructed using an index with similar assets and weightings as the benchmark. They aim to deliver returns that mimic that of the index they track and are traded on an exchange. Currently in Australia, ETFs are only available for passive investment strategies.

Managed funds can engage in an active investment strategy to “stock pick”, which involves market timing, momentum strategies and other strategies in search of alpha (risk free return) not yet priced into the market). Hence, selecting a fund manager that can beat the market is paramount. Index managed funds can also use a passive investment strategy, whereby they typically track a broad, market cap weighted index like the S&P 500/300.

Key differences and benefits of an ETF

  • ETFs can be readily traded by any broker or brokerage platform. Conversely, some managed funds have restricted access and are only available through a wrap platform.
  • ETFs transact in the same way as a stock listed on an exchange. The market is transparent, and prices are updated constantly, and trades can be executed over the course of a day. Managed funds are only transacted once a day.
  • Purchasing an ETF will require you pay a brokerage for each transaction. Managed funds on the other hand allow you to make regular contributions without paying any transaction fees. Hence, you will need to make a judgement between brokerage fees vs management fees. However, ETFs usually have lower management costs that a managed fund, which outweigh the additional transaction costs. For long term investors, ongoing management costs will be paramount, as these are the main drag on performance over the life of the investment. For short term investors, transaction costs may represent a larger proportion of the holding cost.

LICs vs. Managed Funds

A Listed Investment Company (LIC) is an investment, listed on the exchange which operates like a managed fund, with an external or internal fund manager who selects and manages the company’s investments. This enables investors to invest in a range of assets including shares, property and interest-bearing deposits.

Key differences and benefits of a LIC

  • LICs are close ended, meaning they do not issue new shares, or cancel existing shares as investors join or leave. Instead, they issue a fixed number of shares in an initial public offering (IPO). Investors then buy and sell these shares on the exchange. This allows a fund manager to concentrate on the investment selection without having to factor in the possibility of money leaving the fund unexpectedly as in the case of a managed fund.
  • Managed funds are open-ended which means existing investors can cash out at times of market stress, forcing fund managers to sell assets into poor markets. Similarly, when markets are performing well, new applications will increase, forcing fund managers to purchase in times when the market is high. However, because an LIC is close-ended, the only way to cash out is by finding a willing buyer.
  • As LICs are incorporated as companies, they may distribute their income by way of franking credits. This is great for superannuation funds as the fund gets a refund for imputation credits. Dividends also historically provide a more reliable income stream than capital gains.

However, it is important to consider the quality of the manager and the investment team, the time frame you wish to invest over, the need for liquidity and the asset class when choosing LIC or managed fund. For investors who demand liquidity at market value and trust a large institution, managed funds can work well.

 

 

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