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ETFs vs Managed Funds – Which one is best?

ETFs vs Managed Funds – Which one is best?

Active ETFs are a relatively new investment type in Australia with the first one trading on the ASX in 2015. Since that time, they have exploded in popularity and for many people provide a more flexible and cost-effective alternative to your traditional managed fund.

Do active ETFs suit every investor for every type of investment? No, that would be unrealistic. But do traditionally managed funds suit every investor for every type of investment? No, of course not.

It’s just a matter of understanding the differences between the two investment structures and understanding which one may be best for you and your circumstances.

What’s the Difference Between an ETF and a Managed Fund?

Keeping it simple, let’s have a look at the main differences between the two structures.

Starting from the top – Managed Funds vs ETFs…

On one level, both managed funds and ETFs do the same thing – provide you with a diversified portfolio of securities in a fund structure.

The goals of both an ETF and a managed fund are also the same, in that they are trying to outperform a given benchmark. Managers will be using their own strategies and select sectors, weightings and shares that make up the portfolio or fund accordingly. The focus of the ETF or managed fund could be on anything from global equities, a local equities fund or emerging markets.

Both active ETFs and managed funds rely on the skills of the portfolio manager or fund manager to outperform the given benchmark. That’s also one of the key differences between a passive ETF or index fund and an active ETF.

The most obvious difference between the two structures is that ETFs are traded on an exchange. Unlike managed funds, where you can buy and sell once per day (if it has daily unit pricing) via a paper application form, an ETF allows you to buy and sell throughout the day at any time using a stock broking account.

On the surface, this might look like a subtle difference, but for the investor, it can be significant. It makes ETFs far easier to transact as well as making them easier to manage from a tax perspective.

What does all this mean for you and your investments? And how do you choose between the two different structures? Let’s run through the positive and negative attributes of investing via ETFs in more detail to help you make a more informed decision by assessing the key differences.

Positives of ETFs

Ease & Access

As ETFs are quoted on the stock exchange and can be traded through a broker it offers an easy and accessible way to enter the investment market. All you need is a brokerage account. As ETFs are traded through your broker with a HIN number, all paperwork is easily recorded and managed. It makes it easy at tax time to collate your information to give to your accountant.

Because ETFs are traded on an exchange, it also means you can easily see the value of your investment throughout the day.

Value for Money

ETFs can often offer a better cost point for investors than traditional managed funds. What that means is that generally speaking ETFs can sometimes have a lower expense ratio than that of managed funds. Managed funds might come with trailing commissions linked to financial advisors and that can also significantly increase the cost of allocating money into those types of investment products or financial products.

As ETFs and managed funds can vary in their pricing, it’s worth doing some research. It’s also worth comparing ETFs. Make sure that you compare apples with apples on all aspects of the costs associated with investing. This includes indirect and administration costs, not just the investment management fees. But remember, as with many things, you get what you pay for. It’s good to do your homework, and if in doubt, consult with a financial planner.

Flexibility & Liquidity

Being exchange traded, ETFs give you the flexibility to buy and sell your holding when you want. The only limitation is to do so during market hours. If you are looking to buy or sell into a managed fund, your only opportunity is usually at the end of the day, depending on the type of fund, often with one or two day lag in actually receiving your realised cash. Prices of managed funds are usually based on end-of-day prices or NAV, whereas an ETF is priced by the market throughout the trading session where you can see the indicative price. That allows for more opportunities to both enter and exit and also identify opportunities when markets might be presenting them throughout the trading session.

Managed funds do offer investors the ability to add or remove funds through regular contributions or deductions, however, ETFs offer the same type of opportunities to investors. Investors have the flexibility to buy and sell and adjust their holdings throughout market hours.

ETFs also offer more sophisticated investors a degree of flexibility in the way they maintain their positions. ETFs allow investors the option of using stop-loss or limit orders when executing trades. ETFs are also able to be used with margin lending facilities which have the potential to enhance (and reduce!) returns. These are not available to investors in managed funds.

Remember the risks of an ETF should be listed in its Product Disclosure Statement, an important document to read before investing.

No Minimum Investment Amount

As an investor in ETFs, you’re not constrained by a minimum investment amount. Managed funds generally have a minimum investment amount – which can be $25,000 or more – making them less accessible. While there might be a very low minimum parcel size to execute a trade on the exchange, it is far lower than that of the vast majority of managed funds.

Transparency

ETFs offer a far greater degree of transparency than managed funds. Generally speaking, a managed fund is only required to report on its holdings to shareholders on a quarterly basis. That means during that period, investors are not always clear on what the fund is holding or how they’re operating.

ETFs can be required to report on their holdings on a monthly basis, two months in arrears, meaning that portfolio managers must be incredibly transparent and are held accountable to stick to their strategy and risk parameters.

Negatives of ETFs

Brokerage Costs

As with any share you trade on the stock market, there is a cost that the broker will charge you when buying and selling an ETF. This may be akin to a buy/sell spread or entry/exit fee in a managed fund. These days there are many online brokers that offer good brokerage rates – so shop around. For buy and hold investors, the overall costs of brokerage should be minimal, usually less than $20 per trade.

Spreads

In addition to brokerage, investors also pay the “spread” when buying or selling ETFs. The spread is the difference between the price you pay to buy an ETF and the price at which you sell it. The larger the spread, the larger the cost. Unfortunately, there is no way to get around this. Investors who are actively buying and selling on the ASX do have the option of executing their trades as limit orders, which means you can set the price you want to pay. However, you will need to wait for the market to reach your limit order price.

General Illiquidity

While buying and selling ETFs sounds great, not all ETFs are as tradable as others. Some ETFs may trade irregularly or trade at wide spreads. For more information on ETFs and liquidity, please see “What are the risks associated with ETFs”. A good idea is to see the daily volume that takes place in a given ETF to see if you will be able to comfortably enter and exit a position to the size that you require. Remember, with active ETFs, such as eInvest’s, we use a market maker, a third party to facilitate liquidity and to step in to buy and sell units to investors. This means daily volume is less of an issue as the market maker facilitates volumes.

Trading at a Premium/Discount to NAV

When you buy or sell a managed fund, you always receive the net asset value (NAV), so you always get a “fair” price. While there are processes in place that keep ETF share prices in line with their fair value, those processes are not always perfect. Whilst we aim to keep this to an absolute minimum, an ETF might trade at a premium or a discount to its NAV.

Important Points About Active ETFs and Managed Funds

ETFs and index managed funds are highly effective simple ways of constructing a cost-effective investment portfolio and are good investment options for all types of investors.

Both active ETFs and managed funds are useful depending on your individual requirements. While there are a lot of positives of active ETFs, such as flexibility, liquidity and pricing, managed funds can suit an investor looking to regularly invest or withdraw funds.

Active ETFs and managed funds are both highly transparent, however, active ETFs will allow you to track both the holdings and the money manager’s strategy closely. Both can also give you exposure to a broad range of asset classes, sectors and countries and must comply with Australian financial securities law and have product disclosure statements.

Thanks to the benefits of investing in ETFs and active ETFs the marketplace continues to grow in Australia, giving investors a wide range of products available to them.

Why Active ETFs?

Here at eInvest, we like active ETFs. It’s our business. Our vision is to provide all Australians greater access to investment options suitable for them to grow their wealth and we think that ETFs and active ETFs are a good way to do this. We think that ETFs suit many different types of investors, for many different roles in your portfolio. Financial advisors are helpful for navigating these roles.

For example, active ETFs can offer investors the ability to generate steady income such as with our eInvest Income Generator Fund, or capital growth through our eInvest Future Impact Small Caps Fund. The possibilities are endless with active ETFs and investors are able to find a strategy that suits the needs of their broader portfolio and risk appetite.

Disclaimer: Please note that these are the views of Camilla Love, MD of eInvest, and is not financial advice. To find out how to invest in our active ETFs, visit here. The product disclosure statement and more can be found at www.einvest.com.au