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Ready made portfolios all the rage

This article appeared in the April 2013 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.

A simple guide on how new investors can use ETFs and LICs.

Photo of Toni By Toni Case, TheBull.com.au

These days you only need about $500 and five minutes to create a nicely diversified share portfolio consisting of around 200 stocks. Indeed, one-stop-shop investment products, such as listed investment companies (LICs) and especially exchange-traded funds (ETFs) have been all the rage since the GFC.

The chart below shows the rapid take-up by Australian investors in products such as ETFs. This is hardly surprising when you consider the US experience; exchange-traded products (ETPs) are the goliath of the US investment market, with combined assets of $1.6 trillion in January 2013.

In essence, many investors in the US own ETFs rather than, or in addition to, direct shares; it is easier and takes less time to monitor one stock than a dozen or more, and when the underlying market goes up, broadly diversified ETFs ride the wave.

ETP growth - from January 2007 to January 2013

Line chart showing ETP growth - from January 2007 to January 2013

Source: ASX. (Exchange Traded Products include ETFs, managed funds and structured products).

Beginner investors can use LICs or ETFs as an entry point into the sharemarket. Rather than weighing up the merits of BHP Billiton versus Commonwealth Bank, simply log into your online broker and buy one stock that does the rest of the buying for you.

iShares MSCI Australia 200 (IOZ), for instance, is an ETF that invests in the top 200 Australian companies; incidentally, its top two holdings are BHP and CBA, followed by Westpac, ANZ, NAB and Telstra. As the sharemarket has bounced back, IOZ has netted a return of 18 per cent annualised.

Refine your focus

If 200 stocks is a little too diversified for your liking, iShares S&P/ASX 20 invests in the 20 largest Australian companies by market capitalisation. There is also a high-dividend ETF, and an ETF that invests in 200 companies in the Small Ordinaries Index - such as Australian Infrastructure, Perpetual and Mineral Resources.

You can buy ETFs that focus on stocks in a particular sector such as Financials, Energy, Property Securities, Metals and Mining, Industrials, Resources, and even physical gold.

Despite weak global growth, commodity prices have risen by as much as 150 per cent since the GFC - which partly explains why ETFs specialising in commodities are popular. China's demand for energy, minerals and grains is growing as the country's wealth increases; demand for commodity-intensive consumer durables - mobile phones, cars and computers - is rising rapidly.

The chart below shows the percentage growth in oil consumption between 2006 and 2011. As you can see, although oil consumption has fallen in countries with slower growth in Gross Domestic Product, such as in Europe, Japan and the US - growth in China and India have more than compensated for the fall elsewhere.

Growth in oil consumption - from 2006 to 2011

Bar chart showing percentage growth in oil consumption - from 2006 to 2011

Source: Percentage growth in oil consumption between 2006 and 2011, based on BP's 2012 Statistical Review of World Energy. Gail Tverberg, OurFiniteWorld.com

The major companies offering ETFs are StateStreet (SPDR), iShares, Vanguard, Australian Index Investments (Aii), BetaShares and Russell Investments. As for the most popular, most investors buy ETFs that broadly invest across Australian shares, followed by ETFs specialising in international shares, then commodity ETFs, strategy-based ETFs (i.e. buy stocks on a "value" investment principle), and Australian sector ETFs.

The top five ETPs by value traded, as at February this year are:

  1. SPDR S&P/ASX 200 (code STW)
  2. ETFs Physical Gold (GOLD)
  3. iShares Core S&P 500 (IVV)
  4. Vanguard Australian Shares High Yield ETF (VHY)
  5. Vanguard Australian Shares Index (VAS).

Listed investment companies (LICs)

LICs are a similar investment vehicle - providing a fully-fledged share portfolio with the purchase of a single stock. Unlike ETFs, which tend to track an index or sector closely, LICs tend to be more actively managed. There are LICs that buy Australian shares, and others that specialise in international shares such as Chinese or US, private equity and even global resource stocks.

At present there are 52 LICs and trusts trading on ASX and 90 ETPs, and the list keeps growing. The newest entrant is Naos Emerging Opportunities Company, a LIC that specialises in buying undervalued smaller companies outside the S&P/ASX 100 Accumulation Index. It listed on ASX in February at $1 and currently trades at 94 cents.

Some LICs, such as Argo Investments (ARG), have been listed on the Australian sharemarket since 1946 (distributing dividends every single year). Indeed, there are few companies with such a long trading and dividend history. Argo's strategy is to buy and hold shares for the long term, rather than trying to get spectacular rewards in the short term from buying high-risk stocks.

The top five LICs by value traded as at March are:

  1. Australian Foundational Investment Company (AFI)
  2. WAM Capital (WAM)
  3. Argo Investments (ARG)
  4. Milton Corporation Limited (MLT)
  5. Magellan Flagship Fund (MFF).

The benefits of buying a ready-made share portfolio using ETFs or LICs is certainly attractive for time-poor investors. But when there are 142 different products to choose from, how do you decide?

The big difference between LICs and ETFs is that LICs are closed-end investment structures (a fixed number of shares are on issue); whereas ETFs are open-ended (new shares can be regularly issued by the ETF provider).

LICs, being closed-ended funds, operate in a similar manner to Telstra or NAB. For example, when you buy shares in the LIC, you are effectively buying the shares from another shareholder. On the other hand, if a large institution wanted to buy $20 million of units in an ETF, the ETF provider can go ahead and issue the units without the share price being affected.

How does this affect you?

In a similar vein to buying Telstra shares - which fluctuate in price according to supply and demand - an LIC may at times trade at a price above what it is worth, and other times lag below the value of its underlying share investments, measured by net tangible assets (NTA).

It is possible, therefore, to buy an LIC at a bargain price - although when it comes to selling you may face the prospect of selling at a loss if the price has dipped in the interim.

ETFs, in contrast, tend to trade around their net tangible assets - meaning in bull markets the price of an individual ETF will advance higher regardless of whether investor demand for the ETF in question is running hot or cold.

At February 2013, LICs including Djerriwarrh Investments, Australian Leaders Fund and Mirrabooka Investments were running at the highest premiums to NTA, one as high as 16 per cent. More than half were trading at discounts one as low as -60 per cent.

As with all investments, be vigilant and pick LICs with independent boards, strong investment credentials and a track record of dividends and performance.

What about cost?

Both LICs and ETFs are considerably cheaper than unlisted managed funds, but ETFs on the whole are a touch cheaper than LICs (largely because of active management of LICs). Management fees for LICs average from 0.13 per cent per annum to 2.7 per cent for the more actively managed. Yearly fees for ETFs range from 0.06 per cent to 1 per cent.

About the author

Toni Case is editor of TheBull.com.au, one of Australia's leading trading and investing site. Each week TheBull's free newsletter offers 18 share tips from more than a dozen leading brokers, tailored share portfolios for income and capital growth, plus trading, investing and super strategies.

From ASX

Exchange Traded Products and Listed Investment Companies have useful information on the features, benefits and risks of both products.


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