LIC vs ETF: Understanding the Differences | Global Masters Fund (2024)

If you’ve been researching the different types of investment options that you can buy into, then you’ve almost definitely heard of both listed investment companies (LICs) and exchange-traded funds (ETFs). At first glance, they appear to be very similar concepts, so what exactly are the differences between an LIC vs an ETF, and which option is best for you?

At Global Masters Fund, our team is here to give you the answers you’re looking for. We’re breaking down the facts and outlining the distinct characteristics of both LICs and ETFs so you can stay informed and make the best decisions for your financial future.

Listed investment companies (LICs) and exchange-traded funds (ETFs) are both investment vehicles that provide investors with exposure to a diversified portfolio of assets. However, there are some differences between LICs vs ETFs, and understanding them will help you to make more educated investment decisions that better align with your financial goals. To help you better understand your options, we will break down the following key differences:

• Their structures
• Levels of transparency
• Management styles
• Associated fees
• Dividend payouts
• Tax implications

The first key difference between an LIC and an ETF is the structure they operate and trade under.

LICs are a type of closed-end investment company that issues a fixed number of shares. These shares can be bought and sold on the ASX, and they may trade at a premium or discount price to their net asset value (NAV).

ETFs, on the other hand, are open-end funds that issue and redeem shares on demand. Like LICs, they also trade on the ASX, but their share prices are designed to track their NAV closely.

The next difference between an ETF vs an LIC is how transparent they are when it comes to disclosing their holdings to their investors.

ETFs generally provide more transparency as many disclose their holdings daily. This can be beneficial for investors who prefer to have a more involved approach to their investments and are looking to monitor their portfolios closely.

Conversely, LICs are only required to disclose their holdings quarterly. As such, they are better suited to investors who prefer to take a hands-off approach and trust the decision-making process of the professionals who manage the LIC portfolios.

Another difference between an LIC and an ETF is their management style. Generally, LICs are actively managed. They rely on a team of professional fund managers to attentively select and oversee the investments in the LIC’s portfolio and make adjustments whenever necessary. This active management style is done with the aim of achieving returns that outperform a benchmark index.

On the contrary, the majority of ETFs in Australia are passively managed, limiting the fund manager’s role to simply tracking the value/performance of a specific index. Rather than attempting to outperform this index, these fund managers aim to generate returns that replicate its performance.

The fees associated with LICs vs ETFs are also notably different. Due to their structure and management style, LICs tend to have higher fees than ETFs. While LIC fees are typically higher, their active management style and closed-end structure also afford investors certain benefits that open-end, passively managed funds may not otherwise provide, including:

• Purchase discounts
• Potential to leverage funds
• Active management expertise
• Unaffected by large investors selling off shares/pulling out cash

Another difference is how LICs and ETFs tend to distribute dividends to their shareholders. Many investors use dividends as a way to boost their income, and the ways in which these dividends are paid can have a noticeable impact on how consistent their income streams may be.

ETFs generally must pay out all their profits in the form of distributions to their shareholders every year. LICs, however, while paying out an annual or semi-annual dividend, have the unique ability to set aside their profits for later use.

This practice lets LICs build up a profit reserve, which they can use later on during times of market turbulence to “smooth” their dividend payouts. As a result, LICs are able to create a more consistent income stream for investors, providing them with more stability and predictability by reducing the impacts of market volatility.

The last key difference you will need to consider when comparing an LIC vs an ETF is the tax implications that both investment options come with. Generally speaking, the taxation treatment of these investments is the same. ETFs and LICs are taxed the same as shares, and capital gains tax will apply if you sell the ETF units or LIC shares for a profit.

As noted above, an ETF must pay out all of its profits to their shareholders each year. This means the investor may receive large distributions in some years and smaller distributions in others, which can lead to changing taxation effects annually depending on the investor’s individual tax bracket.

However, with an LIC, the dividend flow is generally smoother due to their retained earnings and smoother dividend payouts. This makes them less likely to have variable taxation consequences, which can be beneficial for many investors.

It’s important to note that both LICs and ETFs can provide their shareholders with income tax offsets if they are able to distribute franking credits alongside their dividends. This is due to Australia’s dividend imputation system.

When an LIC pays a dividend that includes a capital gain component, shareholders who are Australian residents at the time may be entitled to an income tax deduction. The LIC will advise its shareholders of the portion of the dividend that is attributable to a capital gain, allowing eligible investors to receive a capital gains tax (CGT) discount on that portion.

With ETFs, the capital gains they make may be eligible for a CGT discount if the ETF holds assets for at least 12 months and distributes the gains to shareholders. In this case, shareholders may be able to claim a CGT discount on their share of the distributed capital gains.

It’s important to keep in mind that eligibility for capital gains discounts can vary depending on numerous factors, including but not limited to:

• The type/structure of the LIC/ETF
• The holding period of the investments
• The individual shareholder’s tax circ*mstances

In terms of which option is better when looking at LICs vs ETFs, the winning choice is ultimately up to you to decide as the investor.

Everyone has different financial goals in mind when they invest, and each investor will require their own unique strategy in order to increase their chances of achieving these goals. That’s why it’s important to consider all the facts and use them to determine which investment option best aligns with your financial situation and investment objectives.