What’s the difference between a LIC and an active ETF?
We have had a few questions about what's the difference between a LIC and an active ETF recently and thought I would explore this thought a little further.
First, an LIC is a funds manager that uses their smarts to beat the market or at least their benchmark. Not all LICs trade anywhere near the underlying value of their assets. They can trade at a big discount and sometimes a big premium. The LIC may or may not be that transparent with reporting its holdings or its NTA/performance figures and the fees are much higher plus they usually get a kicker if they outperform. There are also importantly no market makers in the LIC. So, no requirement on the LIC to provide liquidity and close up a discount to NTA and arbitrage any price discrepancy away.
An active ETF though gives you the power of an actively managed fund with greater disclosure of the underlying assets and the NTA at regular intervals. No ‘trust me I have a black box’ investment philosophy. The fees are considerably cheaper and usually have no kickers for performance and trade far closer to the NTA which is published and known usually daily. They are also controlled by market makers that ensure that the price stays approximately close to the NTA. If things get out of whack there are mechanisms to arbitrage the difference away. Not so with a LIC. A trader or market maker cannot buy up the fund as its assets are trading at a big discount and then apply to wind up the fund and liquidate the assets and so make the difference between the two values. That is hard to do. Very hard. LIC managers tend to get upset when their fund gravy train gets taken away from them. They try to close up the discount through better communication (more updates) buy backs and even directors buying the shares. They try but do sometimes fail miserably.
With an ETF you do not have that issue. That is the joy of the LIC. If there are transparent, good communicators and still trading at a big discount with known assets that are liquid, I have referred to them in the past as the Hot Tub Time Machine. Sometimes especially during periods of extreme loss of confidence, the LIC gets whacked whilst the assets it owns bounce quickly and so buying the LIC at a discount is like being able to go back in time to before the rally and buy those stocks. Hence the Hot Tub Time Machine comparison.
At the end of the day, it is horses for courses. ETFs whether passive or active are big business. These used to be called structured products in my day. We created these products for small groups of clients to give exposure to an index, a commodity or a strategy. We sold them with big margins to professional investors. Now they are called ETFs with small margins that are sold by the score to retail investors.
Much bigger business.
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