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LICs (Listed Investment Companies) vs ETFs (Exchange Traded Funds)

March 14, 2017
11 people like this post.

The following question was asked on my Facebook page in response to a recent shared posting that I made about index investing:

“Hi Gary, what are your thoughts on LIC’s as, say, opposed to ETFs for the Australian Market i.e. WHF, AFI, ARG, MLT vs VAS, STW, IOZ, VHY?”

Barry, great question. And an answer that needs quite a bit of research to get specific. Here are some pointers for starters before getting specific:

  • In general, LICs are effectively active equity funds that are listed on the stock exchange. They try to outperform the mainstream stock market indices, typically the ASX200 or ASX300.
    • You might say that LICs were the forerunners to what are now called ‘active’ ETFs as opposed to index ETFs.
    • Index ETFs track a mainstream stock market index, whereas ‘active’ ETFs are actively managed funds that are listed on the stock exchange with the express purpose of outperforming the stock market indices.
  • Research, by the SPIVA Scorecard and others, shows that the great majority (over 95%, probably more) of active equity funds underperform the mainstream stock market indices over the long term, on the ASX and the world over. So, the long-term probabilities are on the side of the stock market indices to beat actively managed funds, which includes LICs.
  • Focusing on a single asset class, the stock market, there is a high probability that LICs will perform better than balanced funds such as those that dominate industry and retail Super funds – and 401(k)s in the US. Balanced funds typically also invest in asset classes other than the stock market that over the long term underperform the stock market. In this sense, over the long term, the probabilities show LICs to be better funds in which to invest than balanced and diversified funds.
  • Like ETFs, LICs tend to have much lower annual management fees than industry Super funds. In the region of 0.08% to 0.2% p.a. (mid to small cap LICs such as Mirrabooka have higher annual fees, around 0.65%) compared to industry and retail Super funds that range between 0.5% and 2% p.a., and index ETFs that range between 0.07% and 0.24% p.a.
  • Being an active equity fund it is obviously possible that a LIC can outperform the mainstream stock indices. Just as an individual with the necessary knowledge and skills can. Some LICs do and some don’t, over the long term. Which LICs to invest in for the long term requires some analysis and scoping of requirements.
  • If your long-term investing requirements are to match the mainstream stock market indices and thereby stand a 99% chance of beating all other active funds, including industry and retail Super funds, especially balanced and diversified Super funds, then seriously consider investing in an index ETF. Those open for consideration, some of which you have mentioned in your question above are:
    • ASX300: VAS
    • ASX200: STW, IOZ
    • ASX100: ZOZI (still relatively new)
    • ASX50: SFY
    • ASX20: ILC
  • If your long-term investing requirements are to potentially outperform the mainstream stock market indices but also take the risk for potentially underperforming them, and also potentially underperforming other actively managed funds, then you could consider investing in LICs. Further to those mentioned by Barry above (WHF, AFI, ARG, MLT) others to consider are:
    • CIN (Carlton)
    • WAM (WAM Capital)
    • WAX (WAM Research)
    • AFL (Australian Leaders Fund)
    • BKI
    • MIR (Mirrabooka – Mid to small cap stocks focus)
    • plus others…

There are many variables that an investor might include in their analysis to choose a LIC in which to invest. A simple variable might be how they have performed in the past even though we are warned that past performance is no guarantee of future performance.

This excludes annual fees and dividends which could be the difference over this 14-year period between outperforming the ASX200, or not. Dividend yields vary at the moment, and over the years, between LICs themselves and between the indices by as much 2% p.a. For example, current yields are 4.23% for MLT (Milton), 4.17% for AFI, 4.05% for ARG, 3.8% for WHF compared to index ETFs of 3.78% for STW (ASX200), 4.03% for VAS (ASX300) and a whopping 5.62% for ILC (ASX20).

Note too that the journeys are all different, meaning that depending on where you might jump on or off the journey of a particular LIC will make a difference as to what returns you get. However, the journey for an index ETF is consistent; it is that of the stock market benchmark.

Note that WAM’s performance was way below the ASX200 by March 2009. Also, WHF has been the worst performer over this period – it has achieved just over half of the profit that could have been achieved by investing in the ASX ETF, STW, excluding dividends.

The following chart shows two LICS that have performed well over the 14-year period, CIN (Carlton – green/red bars) and MIR (Mirabooka – black), both outperforming WAM (brown) and the ASX200 (blue). However, be careful, both of these are much more illiquid than, say, AFI and ARG, which average daily turnover of around $2.1 million and $6 million, respectively. Whereas CIN and MIR average daily turnover of around $100,00 to $140,000. This means that selling a relatively large parcel in either of these two LICs could be very difficult in times of adversity. Note that STW (ASX200 ETF averages around $8 million daily turnover.

For my liking, I prefer the long-term stability, consistency and most importantly, predictability of outcomes of index ETFs over LICs. As soon as there is choice between different LICs there is variation of outcome and picking a long-term performer suddenly involves numerous variables with the high probability that the index will be underperformed.

Whilst a smaller universe from which to select than say, stocks or active managed funds (such as Super funds), the long-term investing problem of picking a performing fund over the long-term still remains with long-term research showing the probabilities still being stacked against the investor.

Barry, I trust that this provides an answer to your question.

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