Managed Funds or Exchange Traded Funds (ETF)?

Welcome to Finance and Fury. ETFs vs managed funds – Same same but different – when to use

In many ways, managed funds and exchange traded funds (ETFs) are the same. They are both investment vehicles that allow investors to pool their funds with other investors through using a unit trust structure

But looking deeper there are many differences between the two types of investments – so in this episode we will look at the pros and cons of each, when to use them and when not to

As a quick summary of what managed funds and ETF are

1. ETFs – more often associated with passive investments as many simply tracking an index (for example the ASX200 or S&P500), or the price of a commodity (for example gold)
   1. There are some specialist ETFs – ‘smart beta’ or ‘thematic based’ investments are becoming more popular along with active investment managers – but still nothing compared to managed funds
2. Managed funds – wider array of choice of investments and management styles – there are thousands of active investment styles across almost every conceivable asset and sub class – along with index tracking
3. Either way, they allow you to pool your investments with other investors to access a diversified range of investments

But they do have many Differences –

1. Listed vs Unlisted – This is probably the biggest and most obvious difference between a managed fund and an ETF
   1. Managed funds are unlisted – e.not listed on a securities exchange and not traded daily like shares – this means that the units purchased directly from the manager
   2. ETFs are securities listed on a securities exchange and actively traded
      1. The underlying investments themselves are listed (e.g. shares within the ASX200), the key difference here is that the actual vehicle or instrument is also listed.
   3. This one major difference between managed funds and ETFs is source of most of the remaining differences and pros and cons of each of these investments
2. Liquidity – difference in how buying and selling work, along with the time it takes to get money
   1. ETF – being a listed investment, an ETF, must have a buyer and a seller
      1. no different to trading a normal share, and is administered and regulated in the same way
      2. One difference between ETFs and shares, is that occasionally if there is no willing buyer if you are looking to sell, the ETF provider can be a ‘market maker’ to step in and provide liquidity should the level of volume required isn’t present – this also helps to maintain accurate pricing

• This can be completed due to an ETF being an ‘open-ended’ vehicle – the same as managed funds – therefore a market-maker can exist to also create new units in the event there is demand and no corresponding offers to sell – this way the price of an ETF doesn’t skyrocket beyond their underlying holdings value an ETF

1. Settlement time is also the same as shares – i.e. takes two business days after the transaction (T+2).

1. Managed fund – rather than trying to sell your assets to another investor, all purchases and sales are handled directly by the fund manager – i.e. you buy and sell your units to the manager
   1. Sale or purchase orders are normally fulfilled on a daily basis for funds that hold listed/liquid investments – some exceptions for illiquid investments
   2. Managed funds are open-ended, meaning should new investors wish to join, new units can be created – but also destroyed if investors sell out –

• Managed funds are technically less liquid than ETF in many cases – with Australian share funds taking around a week to redeem funds and international investments up to two weeks

1. The price the units are sold at typically at a fixed price for all purchases & sales, as determined by the Net Asset Value (NAV) of the underlying investments

3. Pricing –
   1. Managed fund – being unlisted, is most commonly, priced once a day based on prices at the market close
      1. Can vary depending on the fund manager and asset classes (e.g. Alternatives) – generally, a managed fund of an actively traded asset class like ASX shares would expect to provide pricing on a daily basis.
      2. When an order is made, many times you are purchasing the units at the close price of the following day due to timing issues – For many managed funds purchased through platforms – if the orders are placed before 12pm Sydney time, then you can pick up the closing price of that day – but if the manager receives your order after this time, it is the next days closing price
   2. ETFs trade during the ASX trading hours – 10am to 4pm – Therefore, the price of an ETF can change during market hours
      1. Whilst it is the objective of the ETF provider to ensure that the market price closely mirrors the NAV via both market disclosures of the NAV and the engagement of a market maker – it is possible for an ETF to trade at a price that is either higher or lower than the actual underlying value of the unit being traded – as the provider of the ETF may only choose to update the actual Net Asset Value (NAV) of each unit at the end of the day
   3. Tax comparison – Whilst both investments are structured as unit trusts, there are some differences
      1. Most managed investments do not pay tax as long as they distribute all income and net realised capital gains earned in any year to unitholders – this is why any income from a managed fund is referred to as a distribution – as it is made up of the dividends, FCs and realised capital gains –
         1. The taxation liability falls on the individual investor and is paid at the investor’s marginal rate of tax.
      2. Whilst an ETFs is technically the same, being a unit trust – providers can in some instances be more tax efficient than managed funds
         1. The reason for this is based on the fact ETFs trade on the securities exchanges and the function that market makers play within the transfer of ownership when others are buying and selling
         2. To explain this – the units for an ETF are bought and sold on the secondary market, rather than directly with the manager in most cases (not the case when there is nobody on the other end of the deal) – But when this happens – market makers purchase new units from the fund and sell those units via the secondary market.

• So when investors buy and sell ETF units the fund is not impacted if buyers and sellers meet in the market – or until the market maker fully exhausts their inventory – i.e. run out of shares to loan the ETF provider to avoid them having to sell – as someone is selling their units in the ETF to another investor, so the provider doesn’t need to sell the underlying assets to facilitate this

1. In contrast – unlisted managed funds have to meet each redemption by selling assets in the fund – increasing the number and impact of tax events – even though the average number of sell orders will not amount to much in normal conditions – if there is a large number of people wishing to redeem from a managed fund, there could be a lot of capital gains shared between all unit holders realised –
   1. But generally, people don’t redeem from managed funds that are performing well – i.e. have large amounts of gains – they redeem from underperforming funds on mass
2. In essence, the difference derives from the fact when faced with a redemption, an ETF portfolio manager may not need to sell the underlying investment (e.g. shares) to convert into cash to fund the departing investor – however, a managed fund may be required to sell assets to fund a redemption request
   1. This can potentially lead to a capital gains tax liability for all the remaining investors in the fund.
   2. This is dependent on the underlying structure of the ETF
3. Costs and fees – Purchase costs and ongoing management fees for holding the investment differ between each of these investments
   1. Holding costs – It is generally thought that the average ETF have a lower MER or ICR than the average managed fund – this is true on average – but negates that the average ETF is passive in nature and has a lower management expense
      1. passive investments are by nature and design priced lower than active investments – fraction of a percentage
      2. You will pay more MER/ICR for specialised asset classes and investment strategies that typically incur higher transaction and holding costs – investments in private equity, alternatives, small and microcap shares, private credit, infrastructure or absolute return funds will normally attract higher MERs due to this – which are predominately provided by managed funds
   2. Purchase costs – also could be called the transaction costs – these will differ between ETFs and Managed Funds due to their listed and unlisted natures –
      9. For listed investments – you pay a brokerage fee – this will depend on the broker that you use – may pay $9.95, or $20 for a purchase of up to $10k – per purchase
      10. For unlisted investments, the manager charges you a buy/sell spread instead and not a flat fee – this can range from 0.04% for index funds, all the way up to 0.7% is the highest I have seen for an alternative fund – so for a $10k investment this could range from $4 to $70

• Just note that if you buy $10k of an ETF, you will get that value and be charged an additional brokerage fee – for the buy/sell spread, this is taken out of your invested value – so you end up with the next amount invested

1. A key cost difference is that whilst managed funds can often necessitate the use of an investment platform such as a Wrap or Investor Directed Portfolio Service (IDPS), ETFs, like shares, can be purchased and held with nothing more than a low-cost online trading account.

6. Access – Managed funds purchased through a platform or directly with the manager – but minimums can apply

When to use – pros and cons – no advice – just general information

1. Less range of investment options in ETF – managed funds still have a greater range of investments
   1. This may change over time as more ETF providers come to the market
2. Liquidity – Quick purchases or sales – often ETF can be better
3. Pricing – timing risks with a managed fund – but you are getting the NAV – ETFs can price can be above or below the NAV
4. Concerned about CGT – passive ETF may be better – lower turnover for passive investments
5. Fees – MER/ICR can be higher for managed funds – due to types of investments – ETFs certainly feature a higher degree of passive strategies making sector-wide comparisons skewed to lower ongoing fees
6. Costs for purchasing investments – Monthly investments –
   1. Lower levels of regular investments, managed funds can be better suited – especially for index funds
   2. If you plan to invest $1,000 per month into a range of different investment to diversify across indexes – say 5 different funds – this may cost you $50 in brokerage costs – or 5% of your invested value – in managed funds that are indexes with low transaction costs – this may cost you $0.4
7. Limited funds –
   1. Platform
   2. Direct ETF purchase

Summary – Despite the fact that there are clear similarities between ETFs and unlisted managed funds, they do bring their own respective variations.

1. both options provide investors the ability to achieve significant diversification, by pooling their funds with other investors to achieve scale far beyond their own individual investment.
2. Both structures offer access to a range of asset classes and this can be especially useful in accessing thematics or tracking indexes, for which ETFs are commonly associated – but they are continuing to move into the more asset classes as well as active management products.
3. But they do have differences –