Closed-ended investment entities such as listed investment companies (LICs) or listed investment trusts (LITs) have a fixed capital. When investors seek to reduce their investment in a LIC or LIT, they sell their shares/units on an exchange like the Australian Securities Exchange (ASX) to a new owner. Importantly, the LIC or LIT itself has not had to sell any investments during this process.
This process contrasts with the actions of open-ended managed funds and exchange-traded funds (ETFs), where investor deposits and withdrawals result in the fund having to repeatedly buy or sell underlying investments to apply or liquidate cash balances.
Because of this structural difference, closed-ended funds provide unique advantages to investors, the broader economy and the financial markets system.
The strategic, cost and tax benefits of a closed-ended structure for investors
Open-ended managed funds and ETFs must repeatedly buy and sell assets to match the continuous ebb and flow of investor deposits and withdrawals. These repeated purchases and sales incur transaction costs and crystallise tax liabilities on gains. In certain circumstances where there have been large withdrawals, ongoing investors in open-ended funds may also be left with an undue proportion of hidden deferred tax liabilities.
In comparison, LICs and LITs, which have a fixed capital, do not face this additional cost and tax burden.
Strategically, a LIC or LIT having a fixed capital has money to invest when other investors are fearful sellers and assets are cheapest. In contrast, open-ended funds and ETFs become forced sellers of assets into cheap and fearful markets to fund net investor withdrawals, and equally, must buy expensive assets when investors deposit funds during periods of exuberance.
LICs/LITs raise capital periodically through block capital raisings. By coordinating with other investors as part of a single block, underlying investors have collective buying power when it comes to the pricing, success or failure of share issues. History shows regular examples of share issues that have been repriced, restructured or cancelled as the result of collective investor feedback.
