With savings accounts earning an average of about 0.30 per cent, investors are increasingly looking to other vehicles for better returns.
One of the easiest ways for investors to seek better returns without the pressure of trying to pick stocks themselves, has been through Listed Investment Companies (LICs), and more recently through Exchange Traded Funds (ETFs).
While LICs have been around for almost 100 years, ETFs are a much newer player in the investing landscape.
Both structures are listed investments, so can be bought and sold on the stock exchange, both generally offer low fees, are tax efficient, and both are pass-through vehicles for franking credits.
So which is better for your circumstances?
Exchange Traded Funds
While relatively new, ETFs have exploded in recent years, with 194 listed on the ASX, with more than $47 billion in funds.
Consumer group Choice considers ETFs the cheapest way to track the performance of a particular share index.
Bought and sold like shares (therefore attracting a brokerage fee), ETFs are trusts that issue units.
They have low management fees and allow you to diversify your portfolio without having a large amount of money to invest – with one trade, you can become a shareholder in hundreds of companies.
The Australian Shares Index ETF from investment company Vanguard, for example, charges 0.1 per cent in management fees, while its Total US Shares Index has an annual fee of just 0.03 per cent.
They can be based on a broad portfolio or around a particular investment strategy, be based on commodities and currencies, be sectoral and be either domestic or international in their make-up.
Naturally, returns vary depending on the provider and the portfolio.
In a July 2019 review of ETFs in Australia, comparison site Canstar detailed one-year returns ranging from -1.99 per cent on a commodity-based ETF to 24.6 per cent for a property-based fund.
Vanguard has provided a sample of the returns on some of its more popular funds as follows.
Listed Investment Companies
The LIC market in Australia has 113 products and accounts for around $43 billion in funds under management.
ASIC’s Moneysmart site explains that LICs are incorporated as companies (listed on the stock exchange) which then invest in other companies, typically listed on the stockmarket.
Whereas ETFs generally track an index return and don’t aim to outperform that index, an LIC may use the index as its benchmark, but actually seek to outperform it.
While an ETF is regarded as a passive investment, an LIC is seen as an active one.
(But more recently, ETFs have come on the market that are actively managed, either fully or partially.)
Whereas ETFs can be created in response to the demand for them, LICs are closed-ended, meaning there is a limited supply of shares available – unless the company raises capital.
As a result, the price of the LIC is based on the price that investors are prepared to buy or sell the share for on any given day.
Those LICs will, therefore, trade either at a premium or a discount to the share’s net asset backing.
AFIC shares, for example, were trading on August 5 at $6.46 against a net asset backing of $6.49. LICs are required to report their net asset backing monthly, but some provide updates more regularly.
So what are the differences?
ETF advocates would argue that LICs are less diversified, less transparent and less liquid than an ETF.
An LIC advocate would argue that ETFs are solid enough in a rising equities market, but in stagnant or falling markets you are locked into a stagnant or falling product. In that situation, you need more active management of the asset to add value, they contend.
Certified financial planner Adele Martin says it comes down to whether you take a passive or active approach to investing – ETFs being more passive, and LICs more active.
Ms Martin likes attributes of both products and recommends that people have a combination of active and passive investments in any portfolio.
In both cases, investors need to understand what stocks they are exposed to within the product, she says.
If you have an ETF linked to the fortunes of the ASX 200, for example, remember that almost a third of that will be made up of finance stocks.
“Yes, you have a diversified portfolio, but 32 per cent of it is exposed to financials,” Ms Martin explains.
“When things are going well, that’s great. But what if there is a sudden regulatory change [affecting banks] you’ve got a high exposure to that.”
In an LIC, she says, you are paying for due diligence and the expertise of a market watcher who can spot up-and-coming stocks with big growth potential.
Stocks such as an Afterpay, for exampl›e, which in July 2017 was at $2.85 and on August 5 was at $25.49.
Conversely, Ms Martin adds that active management doesn’t necessarily guarantee above-average returns.
She points out a 2018 report that showed more than 80 per cent of Australian large-cap funds over the past 15 years failed to beat the ASX 200 index.
And as with any investment decision, Ms Martin says you can never do too much homework.
“Don’t just compare fees, look at what they are invested in and how long they have been in the industry. The longer you can compare, you get a better idea of how they perform,” she says.