It’s easy sometimes for big numbers to roll of the tongue. As in the case of superannuation, for example. Right now, there is something like $2.3 trillion of funds invested in superannuation across the country.
To give that number some perspective, it equates to roughly $95,000 for every person living in Australia. And that’s including children.
But what is perhaps more staggering is how quickly this superannuation pool is growing. The Association of Superannuation Funds of Australia (ASFA) calculates that this pool grew by $60 billion in only three months (up until March this year). That’s over $4.5 billion a week.
In the 12 months prior to that, ASFA calculated that total superannuation assets grew by 11.2%. That’s a massive increase when you consider the size of the numbers we’re talking about.
Of course, all this money has to find its way somewhere — it can’t all sit in cash. That’s why there has been a rapid rise in the number of financial products to cater to this demand.
Listed investment companies (LICs) are one example. Of course, LICs are not new. The two biggest on the ASX — Australian Foundation Investment Company Ltd [ASX:AFI] and Argo Investments Ltd [ASX:ARG] — collectively have over 150 years of history. Between them, their market-cap exceeds $12.5 billion.
As demand has grown, so too has the number of LICs to meet it. There are now around 90 LICs listed on the ASX.
Another product that has enjoyed rapid growth is exchange-traded funds (ETFs). By comparison, Vanguard — one of the major ETF providers — estimates the number of ETFs on the ASX at 130-plus. And there are continually new ones cropping up.
What’s the investment aim?
Both LICs and ETFs give investors the ability to gain exposure to a broad range of stocks through a single holding. And because they are listed on an exchange, they enable investors to readily enter or exit a position. Much the same way as an investor would with shares.
While many investors are aware of the advantages of using both LICs and ETFs, they might be less clear about the difference between the two.
As simple as it sounds, the purpose of an ETF is to match the performance of an index. Note that it is not trying to beat it. It’s job is to match the index as best it can.
To do this, it recreates the portfolio of the index as closely as possible. An ETF on the ASX 200 will hold as many shares as practicable of all the shares in the ASX 200 index.
But LICs are different. And it’s perhaps the biggest difference between the two. Rather than match an index, the goal of an LIC is to beat it. Something that’s much easier said than done.
And this is where it gets hard for LIC investment managers. Employing managers that are skilful enough to beat an index consistently is not something that comes cheaply. That’s why fees charged by LICs are often higher than ETFs.
Because of their scale, the fees AFIC (0.16%) and Argo (0.17%) charge are on par with many of the cheaper ETFs. However, many LICs charge much heftier fees than this — many will charge over 1%. By comparison, index ETFs on the ASX can be as low as 0.14%.
The other issue with LICs is that, if you’re aiming to beat an index, there’s always the chance that you’ll fail. And that can be a negative of LICs. You could end up paying higher fees…only to achieve subpar results.
Trade at different values
This is why LICs will often trade at a premium (or discount) to their asset backing. An LIC like WAM Capital Ltd [ASX:WAM] — which has doubled the annual return of the market for over 18 years and paid a string of fully-franked dividends — trades at a significant premium to its asset backing.
By contrast, LICs that have performed less well will often trade at a discount to their asset backing. In theory, such LICs could be liquidated for a higher value than their share price — something all LICs wish to avoid.
For an investor, this can be really frustrating. It means that their investment is trading at a discount to its true value. Because ETFs track an index directly, this distortion is less likely to occur.
However, with the growing number of ETFs, some are becoming more active in their investment style. For example, there’s an ETF that passively holds the top 20 stocks. It then writes call options over them to generate extra income.
Another ETF uses a dividend-stripping strategy to generate monthly distributions. It buys into a stock (before its ex-dividend date) to collect the dividend. It then sells it, moving on to the next dividend-paying share.
With the huge number of LICs and ETFs listed on the ASX, knowing which ones to buy can be a daunting task.
At my income advisory service, Total Income, we use both LICs and ETFs to help everyday investors like you generate income (as well as other dividend stocks). If you’d like to know more about it, you can check it out by clicking here.
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