Lets compare ETFs and Managed Funds on four key areas:
- Diversification
- Flexibility
- Cost
- Tax Advantages
Diversification - Tie
Diversification is the process of spreading your investment capital across several investments so you do not have excessive exposure to any one particular investment.
With the multitude of managed funds out there you could choose a fund which invests into local shares, international shares, property and commodities all within the one fund. Considering diversification from the view of spreading your capital across several asset classes, some managed funds probably have the edge here as a one stop investment shop to obtain exposure to all these asset classes. ETF investors would have to use several ETFs to obtain the same exposure – easily done.
However when these managed funds invest into say local shares, they might only invest into 14 stocks where as a index tracking ETF such as Vanguard Australian Shares Index ETF invests in over 300 stocks thus providing superior diversification to managed funds.
Another point which needs to be raised is the exposure to each investment. The amount each stock constitutes to a market index is typically calculated by the market cap of the company. If one particular company dominates an index then an ETF investment could be dangerous due to a large exposure to one particular company, a potential fault which should not occur within a managed fund which professionally managed.
Flexibility - ETFs win!
The global financial crisis has highlighted an inherent danger to managed funds – the ability to withdraw your investment capital. Some managed funds froze assets meaning investors could not redeem their investment capital.
In addition to this, it can take weeks to enter or exit managed funds in certain cases and in the process you can be charged excessive entry/exit fees.
ETF investors can buy or sell their units at anytime during the trading day with the only entry/exit fee being brokerage and possibly small slippage (if executed professionally) due to a buy/sell spread.
Costs - ETFs Destroy Managed Funds
Management fees on managed funds can be between 1 -3%pa whereas ETF management fees are typically between 0.09% - 0.5%pa. This can be an enormous saving over time.
ETF investors need to pay brokerage and slippage due to a buy/sell spread when entering or exiting their positions, but this is akin and probably still dramatically less than the entry/exit fee charged by managed funds.
Tax Advantages - ETFs win
Both managed funds and ETFs collect franking credits paid by underlying companies and pass this onto investors.
However due to the roll of market-makers in the ETF investment structure, there is no trading within an ETF fund when individual investors decide to enter or exit the fund. This means there are no tax consequences passed on to investors as a result of entries or redemptions to or from the ETF.
