SMSFundamentals | Oct 19 2018
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ETFs Reach A Milestone
As of last month, the Australian ETF market is now bigger than the 80-year old listed investment company market.
-More funds under management in ETFs
-Greater number of ETFs
-Advantages over LICs
By Greg Peel
The first listed investment company (LIC) appeared on the Australian stock market in 1936. The first exchange-traded fund (ETF) was listed in 2001.
A LIC is an investment vehicle listed on the ASX that holds a portfolio of stocks that are themselves listed on the ASX.
An ETF is an investment vehicle listed on the ASX that holds a portfolio of stocks that are themselves listed on the ASX.
Note that LICs and ETFs are not only confined to stocks, or ASX-listed stocks. Different asset classes and offshore investments are also covered by both.
So what’s the difference?
When a company initially lists on the ASX it does so with a fixed share count. Outside of a secondary capital raising, to buy shares in that stock one must be met by a seller of that stock. A LIC is similarly “close-ended”, meaning that if you want to buy shares in the LIC you must be met by someone else looking to sell.
An ETF is “open-ended”, being “sponsored” by the issuer, who is the portfolio manager. If you want to buy a share (unit) in an ETF you might be met by someone wanting to sell but if there isn’t anyone, the issuer will sell you one, thus creating a new unit. The issuer will also act as buyer the other way around. Units can regularly be created or destroyed.
Indeed, the issuer guarantees to stand on the buy- and sell-sides on a fixed bid-ask spread such that investors can get in or out at any time without the risk of there being no buyers/sellers. In the case of a LIC, if you’re looking to sell in a panic you may not find a buyer anywhere near the price.
What this means is that LICs typically trade at a discount or premium to their net asset value, that being the net value of the share prices of the stocks within the portfolio at any given time. ETFs will always trade at their net asset value. But bear in mind that in big- sell-offs like we had last week, that NAV could be moving south very fast.
To save you the effort, ETF issuers publish that NAV in close to real time. LIC holders have to do the maths. Furthermore, the constituents of an ETF portfolio are also published and any changes made immediately public. LICs are known to be a bit slow in providing this information.
Disruption
Given LICs first appeared so long ago, we might call ETFs “LIC disruptors”.
And like many a disruptor of the past decade, ETFs have been highly successful in doing so. ETF sponsor Betashares has revealed in a press release this week that for the first time, as of September, total funds under management via ETFs has surpassed that of LICs, at just over the $42bn mark.
It took about ten years from 2001 for Australian ETFs to gain traction amongst investors. Over the same period, investment in LICs leapt from around $7bn to a peak of over $30bn as we entered 2008. By 2009, that figure was back to $15bn, before growth resumed.
In 2009, ETFs represented less than $5bn but it was the GFC that provided the inflection point. Interest began steadily growing before FUM started “going parabolic”, accelerating at a faster clip than LICs. From 2009, ETFs have marked a compound annual growth rate of 39% to LICs’ 11.5%.
Part of that success would come down to the number of such products available. There are now 241 ETFs listed on the ASX compared to 110 LICs. And to the variety available. LICs predominantly invest in Australian equities while ETFs come in a vast array of colours and textures, across local equities, foreign equities, fixed interest, currencies and commodities, with equity ETFs in particular offering a range of portfolio choices from the full ASX200 to sector-specific or high yield, growth, value and other combinations.
To that end we note, as Betashares reports, net inflows into total ETFs in September included $408m into international equities to only $184m into local equities and $154m into fixed interest.
ETFs offer an investor’s own portfolio with diversification opportunity while keeping everything on the “stock” market.
But be warned, when the market starts to move, the rush to one side of the ship typically means ETFs will move faster.
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