Listed investment companies (LICs) are just one of many investment types available in today's market. Though common, they’re not as well-known as other investments such as Exchange-Traded Funds (ETFs) . Whether you're taking your first steps into investing or you’re a seasoned investor, there's something to be gained from understanding LICs. In this article, we’ll explore what LICs are, how they compare with ETF,s and the trends shaping their popularity. Ready to get started? Let's go!

What are LICs?

LICs are a type of investment fund that offer a unique way to invest in a broad range of assets. They are structured as companies that use the capital (money) raised from investors to invest in a diversified portfolio of assets. These assets can include shares, bonds, real estate, and other investment products.

In Australia, LICs are publicly traded on the Australian Securities Exchange (ASX) . This allows you to buy and sell shares in the LIC like you would with individual company stocks . The main goal of an LIC is to provide investors with income through dividends and/or capital growth over time.

How do LICs work?

The distinct structure of LICs combines the potential benefits of managed funds with the liquidity and transparency of trading on an exchange. Here’s how they work:

1. Capital raising and listing

A listed investment company raises capital through an initial public offering (IPO) where shares are offered to the public. Once the IPO is completed, the LIC's shares are listed on the ASX, making them available to buy and sell.

2. Investment management

The capital raised from the IPO is then invested according to the LIC's investment strategy. LICs are managed by professional investment managers who decide where to allocate funds to achieve the best returns for shareholders. The investment strategy and objectives of an LIC are outlined in its prospectus. An LIC strategy can range from focusing on specific sectors, such as technology or healthcare; to more broad-based investment approaches.

3. Closed-end structure

LICs are closed-end funds, meaning they have a fixed number of shares that don’t change. This key feature is what makes LICs different from other types of managed funds, such as mutual funds or ETFs. Other managed funds are open-ended and can issue new shares or buy back existing shares to meet investor demand.

Investors can buy and sell shares of the LIC on the ASX, and the price of these shares is determined only by market supply and demand. This can lead to shares trading at a premium or discount to the net asset value (NAV) of the LIC's portfolio.

4. Income and growth

Investors in LICs can potentially earn income through dividends, which are distributed from the profits earned on the LIC's investments. On top of that, investors may experience capital growth if the value of the LIC's underlying assets increases. The LIC's share price then reflects this capital growth.

What are the potential benefits of investing in LICs?

LICs have historically been popular among long-term investors because of several potential benefits they offer. Here are some of their key advantages:

Professional management

• Expertise : LICs are managed by investment managers. Investors can therefore benefit from professional portfolio management without having to actively manage their investments themselves.
• Strategic decisions : Investment managers have the expertise and experience to take advantage of market opportunities and navigate through volatile periods. They make investment decisions with the aim to maximise returns and minimise risks.

Diversification

• Broad exposure: By investing in an LIC, you gain exposure to a diverse range of assets and sectors through a single investment. This diversification can help spread risk and reduce the impact of poor performance from any single investment.
• Portfolio composition: LICs often invest in a mix of assets, including shares, bonds, and sometimes international assets. This can make it easier for you to build a balanced and diversified investment portfolio.

Dividend income

• Regular income: If it performs well, investors can receive a stream of income through dividends paid by the LIC. Since LICs are structured as companies, they can retain earnings and smooth out dividend payments over time. So, shareholders can potentially collect consistent, reliable income.

Access to closed-end structure

• Stable capital base: The closed-end structure of LICs means that fund managers don’t issue or buy back in the same way that open-ended funds do. This stability allows fund managers to focus on long-term investment strategies, which may lead to better investment outcomes.
• Market price dynamics: As mentioned, shares in LICs are bought and sold on the ASX. This can lead to LICs trading at a premium or discount to the NAV of the underlying assets in the portfolio. As a result, some investors might find opportunities to purchase shares at a discount.

Transparency and liquidity

• Ease of trading: Shares in LICs are traded on an exchange, which provides liquidity. Liquid investments make it easier for investors to buy and sell.
• Regulatory oversight: As listed entities, LICs are subject to regulatory requirements, including regular reporting on their financial performance and portfolio holdings. This information is publicly available, and the transparency gives investors insight into how their money is being invested.

Long-term investment focus

• Investment horizon: LICs are often geared towards long-term investment strategies, which can be appealing to investors looking to grow their wealth over time. The focus on long-term investing opportunities rather than short-term market fluctuations can lead to more stable and potentially higher returns over the long run.

It's important to note that while LICs offer several potential benefits, they also come with risks.

What are the potential risks of investing in LICs?

Here are some of the main risks that can stem from investing in LICs:

Market price volatility

• Premiums and discounts to NAV: As LICs can trade at a premium or discount to the NAV, you might pay more for the LIC than its actual worth. This can affect your investment's value and potential returns.
• Share price fluctuations: Like any listed investment, LICs are subject to market volatility. The share price can fluctuate due to investor views, broader economic factors, or changes in the investment landscape. Because of this, the share price may not always reflect the performance of the underlying assets.

Management risks

• Performance dependency: The success of an LIC is closely tied to the skill and decision-making of its fund manager. Actively managed investments have the potential to outperform indexes, but there’s also the risk of underperformance.
• Fees and costs: Management fees and other associated costs for active management can eat into investment returns over time. While LIC fees may be competitive, it's important to understand all costs involved and how they compare to other investment options.

Liquidity concerns

• Trading volumes: Some LICs, especially smaller or niche ones, may experience lower trading volumes on the ASX, which can impact liquidity. This means that selling your shares quickly or in large quantities might be challenging.
• Size and scale: The size of an LIC can also influence its performance. Smaller LICs might not have the same access to opportunities as larger ones, and that may limit growth prospects.

Investment strategy limitations

• Fixed investment mandate: LICs operate under what is called a fixed investment mandate. This might limit flexibility for managers in responding to changing market conditions. If an LIC's strategy becomes less favourable due to such changes, it may restrict the options available to shareholders.
• Concentration risk : Depending on the specific focus of the LIC, there could be a higher concentration risk. That’s where a significant portion of the portfolio is invested in a particular sector or asset class, making it more vulnerable to downturns in that area.

Dividend distribution policy

• Inconsistent dividends: While LICs can provide dividends under the right conditions, there's no guarantee of dividend payments. The dividend policy is subject to the company's performance and the discretion of its board, which may not always align with investor expectations for income.

It's essential to weigh these risk factors against the potential benefits of investing in LICs. Also consider your investment goals and strategy, risk tolerance, and preferred investment style. Do your research, and if you need more help, you can reach out to a qualified financial adviser for guidance.

How do LICs compare to ETFs?

LICs and ETFs are both popular investment options on the ASX that offer investors exposure to a diversified portfolio through a single transaction. However, they have distinct differences in structure, management, and investment approach. Understanding these differences can help you decide which option aligns with your investment goals and strategy. Let’s look at the key differences to be aware of:

Feature	LICs	ETFs
Structure	Closed-end fund; fixed number of shares issued during an IPO.	Open-ended fund; can issue and redeem shares continuously.
Market price	Can trade at a premium or discount to NAV due to fixed share supply.	Typically tracks the NAV closely due to continuous issue and buying back of shares.
Management style	Usually actively managed, aiming to outperform a benchmark.	Mostly passively managed (although some are active), aiming to match the performance of a specific index.
Costs	Generally higher fees because of active management.	Typically lower fees due to passive management.
Investment approach	Potential for higher returns through strategic asset selection. Also a downside risk of underperformance.	Focus on matching market performance, with less risk of significant underperformance.
Dividends	May offer more consistent dividends as the LIC can retain earnings.	Dividend payments based on the performance of underlying assets; can be less consistent.
Liquidity	Share liquidity is influenced by market demand; may be less than ETFs.	High liquidity due to the ability to issue and redeem shares.
Flexibility	Long-term investment focus; less affected by short-term market fluctuations.	Greater flexibility for investors to enter and exit share positions.

Both LICs and ETFs have their own set of potential benefits and risks to consider. The choice between the two depends on an investor's investment objectives, acceptance of risk, and active versus passive investment style.

What are the trends in popularity for LICs and ETFs?

Investment preferences are ever-changing and are influenced by economic conditions, market trends, and investor behaviour. For their part, LICs have a long history in Australia. They’ve traditionally been popular among investors seeking stable income and access to professionally managed, diversified portfolios. However, the emergence and rise of ETFs has introduced a new dynamic. Investors are increasingly drawn to the simplicity and lower costs associated with these passive investments.

ETFs have experienced rapid growth in both the number and assets under management over the past decade. This growth is partly because of their flexibility and lower cost structure. ETFs also offer a wide variety of investment strategies, including passive index-tracking, active management, and thematic investing . These options have made the Exchange-Traded Fund model popular for portfolio diversification.

Still, LICs remain a significant part of the investment landscape. Specific segments of the investor population continue to regularly invest in LICs. They tend to be the preferred option who value active management. These trends point to a diversified market with room for both investment types.

The wrap-up on LICs

LICs offer long-term investors a unique combo of hands-on professional management, diversification, and potential steady income. Though with drawbacks, LICs can be attractive for investors seeking exposure to actively managed strategies and potential capital growth and income. As always, before investing in LICs, do the research, understand your investment aims, and seek financial advice if needed.