When it comes to investing, there are a lot of different options to choose from. Two of the most popular choices are Exchange Traded Funds (ETFs) and Managed Funds. But what’s the difference between them? In this blog post, we will discuss the pros and cons of each type of investment vehicle, so that you can make an informed decision about which is right for you.
Before we jump into the differences between these two investment options let’s look at what each of these popular fund types offers.
What is an ETF?
An ETF is a fund that is passive fund that trades on the stock exchange in the same way as shares do. An ETF provides investors with exposure to an index, sector or commodity for a low investment fee. For example, you could invest in an S&P/ASX 200 Index Fund (which tracks Australia’s top 200 companies) via an Australian Securities Exchange listed ETF such as BetaShares A200 Fund or Vanguard’s VAS Fund. Through one purchase you gain exposure to a wide range of underlying shares.
One of the best things about ETFs is that they can be bought and sold just like any other shares on your chosen investment platform. For fixed price brokerage and automated investing, we highly recommend Pearler.
What is a Managed Fund?
A managed fund is a type of investment that pools money from many investors and invests the money in assets such as shares, property or fixed income investments. The returns on these investments (including dividends) are then distributed to the investors according to their shareholding.
A managed fund is an actively managed fund by professional fund managers who make all decisions about where to invest the money, or it can be a passive fund where the manager simply buys and holds a pre-determined basket of assets.
What is the difference between a Managed Funds and an ETFs?
below we will look at the 5 key differences between a managed fund and Exchange Traded Funds.
Fund Accessibility
As mentioned one of the best parts of investing ETFs is the ease of purchase you can buy them through any stockbroker or online trading platform. Managed funds on the other hand are not able to be traded in the stock market like ETF’s are.
Managed Fund Investments are arranged privately through a financial advisor or through a stock broker if they provide that option.
Fund Liquidity
Similarly to the ease of accessibility ETF’s are referred to as highly liquid due to their ‘open ended’ nature, the reasons and mechanics behind this are pretty complex and the average punter doesn’t need to be concerned with why ETFs are more liquid but the short answer is there is the liquidity comes from the fact that there are no fixed amount of share units available in an ETF. The fund manager can create or remove units in line with shareholder’s demand. This keeps the stock prices in line with the underlying benchmark index.
Managed funds, on the other hand, have a fixed number of units available and as such the unit price can differ from the underlying Net Asset Value (NAV) it tracks. This is not necessarily bad but it can create opportunities for savvy investors to make money by trading in the units of a ‘closed ended’ fund. Again, the average punter doesn’t need to concern themselves with this.
The liquidity in managed funds comes from two factors:
– The underlying assets that the fund invests in
– The ability of the manager to trade these underlying assets
The liquidity of a managed fund is usually lower than an ETF as it takes time to sell the underlying assets. For example, if a fund manager wants to sell BHP shares in their portfolio, they need to sell a large amount of shares, this can take time and affect the price which means they may not be able to get the best price.
Management Fees
The other big difference between ETFs and managed funds is the management fee. If your financial planner recommends a $500,000 investment for you in a managed fund that charges a management fee of 0.75% (some charge up to double this!!), then this translates to an annual cost of $3750 per year. The same amount invested into an Exchange Traded Fund (ETF) that charges a management fee of 0.07% (such as Betashares A200) would only incur an annual cost of $350. This is a huge difference! Over time, this can really add up and eat into your profits.
When it comes to choosing between ETFs and managed funds, always remember to factor in the management fees. The lower management fees are, the better.
Managed fund Management fees are higher because the fund company has staff who research and select stocks that go into the fund so really you are paying for the management and the fund managers stock picking expertise.
Tax Efficiency
The other big difference between ETFs and managed funds is tax efficiency.
Tax Efficiency refers to the percentage of your investment that you get back in returns after accounting for taxes.
ETF’s are seen as more tax-efficient than Managed Funds because they have a lower turnover ratio (i.e., buy/sell ratio). This means that no matter how often the ETF manager sells stocks in order to rebalance the fund, it will always have a lower tax bill than a managed fund.
The turnover ratio of a managed fund is much higher as the manager is buying and selling stocks all the time in an attempt to beat the market. This high turnover results in more capital gains being taxed, and therefore a higher tax bill.
To put this into perspective, say you have $100 invested in an ETF such as the Betashares A200 (ASX code: A200). If stocks are sold to rebalance the fund and there is capital gain of $0.50 per share, then your investment will be worth $99.50 after taxes.
Now, say you have $100 invested in a managed fund that has a turnover ratio of 100%. This means the manager has bought and sold stocks worth 100% of the initial investment. If there is a capital gain of $0.50 per share, then your investment will be worth $99 after taxes.
As you can see, the managed fund has a lower tax efficiency than an ETF.
The higher turnover ratio of a managed fund also means that it takes longer to buy and sell units as there is more liquidity risk involved. This can be costly for us as investors because if you want to get in when the market is high or out when it’s low, then this can be difficult to do. Not that we suggest the Buy High, Sell Low technique but in general if you are topping up your investments at market highs or lows then it can be an issue.
When it comes to tax efficiency, always remember that ETFs are more tax efficient than managed funds. The lower the turnover ratio, the better.
Actively Managed Funds vs LICs
If you have read our Post about ETF’s vs LIC’s you might be thinking that Managed Funds and LIC’s sound very similar but there are a few key differences that you should be aware of.
LICs are open to all investors and can be traded like ETFs on the stock market with a high level of liquidity, whereas Managed Funds are only available through Financial Advisors or Wealth Management Companies.
LICs have a minimum investment amount of $500 (minimum share parcel) and can sometimes have an annual fee as low as 0.07% or as high as 0.75%.
Managed funds usually require a larger lump sum investment and normally will have an annual fee that is typically 0.15-0.5% higher than that of a LIC.
Exchange Traded Funds vs Managed Funds; Which is right for you?
Of course you need to take into account your goals and what investment strategy that requires but if you are looking for a hands-off investment option, then Exchange Traded Funds (ETFs) are the way to go. Managed Funds may provide a higher level of personal service, but at a cost – and there is no guarantee that they will outperform the market. Index tracking ETFs simply follow an index, so will always track the market up and down. They are low-cost and can be bought any time you like, so you have more control over your investment.