Talking the talk

With the array of investment options currently available, keeping track of the key differences is becoming difficult due to the use of abbreviations and industry jargon.

ETFs are open ended index funds listed and traded on exchanges, such as the Australian Securities Exchange (ASX), that invest in a diversified basket of securities that make up an index.

There are different types of ETFs traded on the ASX, which are commonly categorised as:

• domestic index — domestic indices;
• international index — key global indices;
• commodities — gold and platinum; and
• sector index — key global sector indices.

State Street, iShares, Vanguard Investments and ETF Securities all issue ETFs.

LICs are listed on the ASX and are essentially investment companies managed by investment professionals who are mandated to invest into a certain type or range of assets.

LICs are not sold in units, but as they are listed, they have all the characteristics of a listed share and are traded through stockbrokers.

LICs provide exposure to a diversified portfolio of investments across four categories including Australian shares, international shares, private equity and specialist/sector.

A SMA is a professionally constructed and managed investment portfolio of direct shares and cash, structured as one or more model portfolios.

Unlike a managed fund, it is not a unitised investment. Beneficial ownership of underlying shares is retained by the investors or the trustee for superannuation investments.

The shares held within the model are visible and also portable. They are portable between models within the SMA with common stock holdings and from individual shares held by an investor into an SMA, where the stocks are common.

ETFs and LICs are listed investments in their own right. The investor directly owns the units in the ETF, or the shares in the LIC. However, the investor does not own the underlying shares into which the ETF or LIC is invested.

The investor remains the beneficial owner of the underlying shares that are held within a SMA model.

Each of the three different investment types are professionally managed. LICs are managed by the investment team within the company itself or by another group if the investment company has outsourced the investment management function. ETFs and SMAs are managed by the related investment manager.

The most transparent, in terms of visibility in which stocks are held in the portfolio, is the SMA model. Stock holdings can be seen on related software or via online reporting and hard copy client reports.

Stocks held within ETFs are not fully transparent. As the ETF is effectively a proxy investment for a particular index, this means they only provide an indication of the range or extent of stocks that are represented. Subsequently, the investor does not see exactly which stocks are held through any related reporting.

LICs are also not as transparent as an SMA. An LIC may communicate the top stock holdings (normally top 10), but only on a periodic basis, and not for the entire portfolio.

The share price of an LIC can differ from the net tangible assets (NTA) value of the fund/company. This is because the LIC itself is valued according to market demand for the company’s shares, which itself is influenced by the reputation of the managers and not by the worth of the underlying stocks in which the LIC invests.

ETF prices, while not always matching the NTA, commonly trade within a smaller band around the NTA and are less affected by market demand.

LICs and ETFs are not generally viewed as large cap stocks. As a result, an investor purchasing a significant number of shares in either one of these investments (or equally selling a significant number) could potentially move the market and therefore influence the share price. This is due to the generally lower level of market capitalisation in LICs and ETFs compared with the stocks commonly invested into by a SMA.

The value of an investor’s holding in an SMA is simply determined by the value of the underlying shares that are held in the SMA itself. An investor’s value or investment within a SMA will therefore reflect each stock’s share price multiplied by the respective number of shares they hold.

LICs retain realised capital gains. Unlike individual entities as defined by tax law, LICs cannot take advantage of the 50 per cent discount when calculating capital gains tax (CGT) on assets held for more than 12 months.

ETFs are an income pass-through structure, which means all investment earnings, including realised capital gains and franking credits, net of any management fees and costs, are distributed to investors who hold units in the ETF.

SMA investors can take advantage of the 50 per cent CGT discount (33 per cent discount in relation to super investments) on assets sold at a profit after 12 months. Where an asset has been held for more than 12 months and it is sold as a result of either the model manager rebalancing the model, or after the investor has made a redemption that requires stocks to be sold, the 50 per cent discount will be applied (or 33 per cent discount as is the case for superannuation investments).

SMAs provide the greatest level of flexibility in relation to an investor’s ability to transfer investments in specie.

For example, if an investor wishes to invest into an SMA and they already hold a stock that is common to the SMA, the common stock can be transferred into the SMA in specie rather than sold down into cash and repurchased. Note, for superannuation this will be a CGT event where the beneficial owner changes.

SMAs provide the benefit of in specie transfer if an investor wishes to move from one SMA model portfolio to another SMA model portfolio. Again, where there is a stock common to both portfolios, some or all of the investment in that particular share can be transferred in specie to the new model.

This scenario can apply for any number of stocks that are common to the existing SMA model portfolio, the new model portfolio that is being transferred into and/or the investor’s own direct share portfolio (non-superannuation only).

Also, if an investor wishes to exit the SMA model portfolio but determines that they would still like to hold each of the shares directly themselves, an in specie transfer of all shares out of the model portfolio can be executed so that the stocks are then held individually and directly by the investor (non-superannuation only).

An ETF and LIC can be transferred in specie from an investor’s own individual investment portfolio into an investment platform (for ordinary investment only and not for superannuation) if it is an investment that is available and therefore also ‘common’ to the platform. But outside of this in specie transaction, there is no further flexibility as to the underlying shares held within either the ETF or LIC.

LICs and ETFs are listed securities, which means buying and selling incurs brokerage that cannot be netted off or shared across all other investors.

Investors incur the cost of only one brokerage transaction each way for ETFs and LICs. An SMA sees several brokerage transactions occur, one for each share that is held.

SMA investors can benefit from the ability to net off and share transaction costs that take place within each SMA model. For example, if one investor was buying 100 BHP shares and at the same time another investor was selling 80 BHP shares, on a net basis only 20 BHP shares would need to be purchased. This minimises the trade size required for the buyer, but more importantly means that there is no trade required for the seller, so they will not incur brokerage costs.

When buying or selling an LIC or ETF the applicable brokerage cost is fully incurred by the investor. The benefit of an SMA is that brokerage costs can be shared. For example, if there are 50 investors as part of a consolidated buy into an SMA, the brokerage cost incurred per share is shared across each investor. This provides a saving in brokerage costs for all 50 investors.

As LICs and ETFs are traded as direct shares, specific licence conditions are required. If an adviser is licensed to recommend managed funds, they can generally recommend SMAs without changing their existing licence.

Stuart Fechner is distribution development manager — investment products at Aviva.