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Jemima Joseph is an associate analyst with Morningstar.

Listed investment offerings such as exchanged-traded funds (ETFs) and listed investment companies (LICs) have provided investors with transparency, liquidity, lower fees and investment performance.

Despite their rise in popularity, the technical differences between the two offerings cause confusion among investors, especially when it comes to determining the suitability of these vehicles within one's broader investment profile.

What are ETFs and LICs?

The Australian Securities Exchange (ASX) defines ETFs as "investment funds, traded on an exchange, that invest in a basket of securities or other assets and that generally seek to track the performance of a specified index or benchmark (such as the S&P/ASX 200 index)".

State Street's SPDR S&P/ASX 200 Fund (STW) was the first Australian ETF to be launched on the ASX back in 2001. Since this launch, the Australian ETF market has taken leaps and bounds, capturing a combined market capitalisation of $5.1 billion as at 30 June 2011.

LICs, similarly, are traded on an exchange. However, the listed company buys shares in other companies, therefore providing investors with exposure to a professionally managed portfolio of assets held by that listed company.

Unlike ETFs, LICs have a long and established history in Australia and as at 30 June 2011 had a total market capitalisation of $16.8 billion.

It is evident that with both offerings being listed products, investors gain the buy and sell flexibility of a share. It is, however, imperative to go beyond this and examine the differences between these two offerings in order to determine their viability within one's broader investment experience.

Legal structure and taxation implications

Similar to traditional unlisted managed funds, Australian ETFs are structured as trust vehicles. In adopting this legal structure, ETFs are not required to pay tax on their income and realised capital gains. As such, taxation obligations are passed on to the investor, who is then required to pay tax (at their individual marginal tax rate) on any gross income, franking credits and realised capital gains.

In contrast to this, LICs are structured as a company. Under this legal structure, LICs are required to pay company tax on any income and realised capital gains. LICs are governed by the Corporations Act, which details that a company can either retain profits or pay them out to investors via dividends.

Any dividend income and franking credits distributed to investors will give rise to individual taxation obligations, the very same obligations experienced by ETF investors. As such, it is evident that the different tax treatments may not significantly impact on an investor's after-tax profit.

Investment structure: open or close-ended investment?

Many investors are dumbfounded by the two product offerings and the technical differences that arise out of the different structures.

ETF are open-ended investments. This means they do not have a fixed number of units on issue. For example, if a large institution wanted to buy $100 million of units the ETF provider can go ahead and issue this without the share price being affected by the market's demand and supply requests.