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Our article about Share Packs discussed one way of achieving diversification quickly and easily. Many investors, however, are choosing instant, broad diversification by investing in Exchange Traded Funds (ETFs), and Listed Investment Companies (LICs).

We’ll look at them one by one as they are a little different.
 

Exchange Traded Funds – ETFs

Australian ETFs are index funds.

  • This means they are ‘passive’ investments that track market indices rather than try to outperform them. So, for example, you can buy an ETF which tracks the top 200 Australian shares (ASX 200).
  • As index funds, ETFs are an easy way to diversify your investments, with lower fees than traditional managed funds (lower but not zero).

An ETF is a unit trust, the units of which you can buy and sell through your broker.

  • As a unit trust, ETFs are relatively transparent, with the value of underlying assets (net asset value or NAV) published every day, and estimated every 15 minutes.
  • ETF prices typically trade very close to the NAV because market makers can issue or redeem units if the price strays too far from NAV.
  • ETFs pass through all gains and losses direct to unit holders, including dividends and franking credits and capital gains and losses.
  • The liquidity of ETF units is driven by the liquidity of its underlying shares, so of you want to get out of units in, say, your ASX200 ETF quickly, you usually can, without suffering a big discount.

ETFs are also available for other assets like as international shares, fixed income, foreign currencies, precious metals and commodities.

  • ‘Synthetic ETFs’, rely on synthetic financial instruments when it’s impossible or expensive to buy, hold and sell the underlying investment (like commodities). These can involve additional risks.

 

Listed Investment Companies – LICs

LICs tend to be much more actively managed

  • They seek to outperform the broader market.
  • Emphasis is placed on active stock selection, weighting holdings, and usage of leverage (borrowings) and/or derivatives.
  • As such they typically involve higher fees than ETFs.

An LIC is a company, the shares of which you can buy and sell through your broker.

  • Like any other listed company, shares in an LIC can trade at a significant premium or discount to their NAV. This can be an advantage, as investors sometimes have the opportunity to buy at a discount. It can also be a disadvantage if an investor wishes to sell at a time when there is a substantial discount.
  • Also, like other listed companies, LICs make profits, pay tax and then decide what dividends to pay to shareholders. As such they can choose to smooth their dividends for investors.
  • The liquidity of shares in an LIC is driven by supply and demand for that one stock, so if you want to get out quickly, you may push the discount into even deeper territory.

As always, we suggest you seek personal financial advice before embarking investing in LICs or ETFs.
 

Are they the same as Managed Funds?

ETFs and LICs are collective investment vehicles that pool together investors funds, and that you can buy and sell on the stock market.

Of course, these entities employ managers and this involves additional costs to investors (compared with investing directly in the underlying companies).

So these investments are a sort of half-way house between direct investment and traditional managed funds.

 

What are your thoughts?

Do you own ETFs or LICs? Is there more you’d like to know about these investments? Join the conversation — leave a comment below and let us know what you’re thoughts are.