How do ETFs and managed funds differ and what are the key features of both? Which one is right for you?
Keep on reading to understand the ETF vs managed fund difference better, so you can choose the best investment option for you.
Are ETFs the Same as Managed Funds?
According to the Australian Securities and Investments Commission, ETFs are managed funds.
A managed fund is a trust where the investor’s funds are pooled. It is run by a professional who acts as a responsible entity, investment manager and custodian.
The purpose of a managed fund is to provide a diversified portfolio of securities as there are several types of managed funds you can invest in depending on your risk appetite. Managed funds are not listed on the stock exchange and are typically funded through regular contributions by investors or with superannuation money your employer pays into your super fund.
ETFs are listed versions of managed funds that can be traded on the stock exchange just like shares. So instead of investing through the fund management company, investors buy a share of the fund on the stock exchange.
This seemingly small difference is important as several other aspects depend on it. For instance, since they are traded using live prices, ETFs are subject to market volatility, unlike managed funds, whose value is determined by NAV (the total value of assets in a fund’s portfolio). These, and other key differences, are something investors should be familiar with before getting into the investing game.
ETF vs Managed Fund: Similarities
How similar are ETFs and managed funds?
You might be interested to learn more about index funds and how to invest in one in Australia.
Ownership of assets
From a legal perspective, ETFs and managed funds are types of trust structures where all assets are put together and collectively owned by a trustee who acts on behalf of the unitholders. Each tax year, investors collect dividends and franking credits (if eligible) from the fund as well as realised capital gains.
This makes both ETFs and managed funds a great source of passive income—you can use the distributions to reinvest into the fund or take them in cash payments.
Portfolio Diversification
Investing in managed funds and ETFs gives you exposure to a wide range of assets, industries, and market sectors. You can also use ETFs and managed funds to invest in US shares and other international stocks, further diversifying your portfolio.
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What’s more, since you pool your money with other investors, you can get access to a broader range of assets that are not easily accessible to individuals, such as investing in commercial property, private equity and government bonds.
Having a diversified portfolio not only increases your chances of higher returns (since you are branching out across sectors and industries) but also limits your risk exposure (if one asset underperforms you can offset the loss via other units in the fund).
Management
Both of these financial vehicles can be actively or passively managed. Which option you choose depends on your investment philosophy.
Bear in mind that in Australia, most ETFs are passive, i.e. they track a market index. Active ETFs are also available but are not as common—these aim to outperform the benchmark index rather than mimic its performance.
Structure
ETFs and managed funds are open-ended funds, meaning there is no limit on the number of units that can be issued. As demand increases or decreases, the number of units available for purchasing will rise or fall proportionally. The same goes for selling units.
Regulation
ETFs and managed funds must follow regulations set out in the Corporations Act for registered schemes. The most important rule is that a third-party custodian must hold the underlying assets, rather than the product issuer—this way they can’t be seized by creditors for debt collection.
Managed Fund vs ETF: Differences
As mentioned earlier, ETFs are a type of managed fund but there are crucial differences between an ETF and an actively managed fund that investors should be aware of.
Pricing
The biggest difference between an ETF and a managed fund is the way they are traded.
ETFs are exchanged during trading hours at current market prices, just like shares, which means that the prices change continuously. On the plus side, you are paying for the actual value of the asset on that day, but it also means that ETFs are subject to market volatility and, therefore, riskier than traditional managed funds.
Sell and buy orders for a managed fund are executed at the end-of-day price or revised net asset value. In other words, no matter when you place an order, you will get the same pricing as everyone else trading that day. This way there is no intraday price volatility, but it also means that investors in managed funds will not know the exit price until the following day.
Accessibility
ETFs are much more accessible than managed funds. To start trading in ETFs you just need to open an investment account through an online broker or financial advisor.
To invest in managed funds you need to go through an application process which is not only time-consuming but requires a lot of paperwork as well, including providing various KYC and AML documents.
Minimum investment
Managed funds usually require a bigger initial investment (typically around $5,000 to $100,000), whereas with ETFs you simply need to meet the minimum deposit requirements of your broker—most top-rated online brokers only require a $10 minimum deposit.
Adding new funds
With managed funds, you can add money to the fund at any time through regular contributions, or remove money with deductions, making them perfect for dollar cost averaging.
Investors in ETFs can also buy or sell additional assets at any time during trading hours, although they will be charged a brokerage fee on every transaction.
Fees
Managed funds tend to incur higher long-term fees than ETFs. With the former, you might be required to pay management fees (for the expertise of the fund’s manager and the team of advisors), performance fees (which can go as high as 20%) and buy/sell spreads, whereas ETFs are only subject to commission.
Brokerage fees may be fixed, unlike the managed fund’s buy/sell spread; however, they are charged on every transaction so they might add if you trade frequently. With ETFs, it might be better if you save up enough funds and invest more money less frequently or opt for a low-cost broker, or better yet, an online broker that does not charge any commissions on ETFs.
Trading Flexibility
Since ETFs are traded on the ASX, investors used to this trading environment will have no issues. What’s more, they allow the use of advanced trading strategies such as order price limits and stop-loss orders. Investing in managed funds does not offer the same level of flexibility.
Transparency
Another key difference between an ETF and a managed fund is portfolio transparency. ETFs are more transparent regarding underlying assets as investors have all the information about the holdings in the fund. This data is also updated on a regular basis and easily accessible on the manager’s website.
Managed funds are less transparent since fund managers are not required to reveal the underlying assets in which they have invested. They may sometimes list the top largest holdings, however, even with this, it can be hard to track where your money is going.
Tax efficiency
ETFs are more tax efficient than managed funds as you do not have to pay CGT until you sell your share in the ETF. Since managed funds are a pool of assets, each unitholder is liable for capital gains tax when another investor realises a gain. There are some legal ways to reduce capital gains tax, but it is important to remember this managed funds vs ETF distinction when choosing your next investment opportunity.
Liquidity
ETFs are highly liquid since they are traded on the stock exchange. By contrast, managed funds are fairly illiquid since buy and sell orders are only processed at the end of the day.
This can also make it harder to redeem your money, especially during times of market dislocation, for instance, in the event of a stock market crash. Even in normal conditions, the issuance of redemption can take a couple of days with managed funds, not to mention the tons of paperwork involved.
Bottom Line
So, is a managed fund better than an ETF? Which one is right for you?
ETFs and managed funds are both low-cost financial vehicles that provide instant diversification of assets. Which one you choose depends on your investment strategy and personal preferences—if you want to invest in a transparent portfolio with greater trading flexibility and liquidity, ETFs may be a better option. Managed funds would suit investors who wish to gradually put savings into their investments and trade more frequently.
The bottom line is that it doesn’t have to be one or the other. You can choose to invest some of your money in managed funds and some in ETFs, thereby getting a taste of both options.
1. What are the disadvantages of managed funds?
One of the biggest drawbacks of a managed fund is lower transparency into where your money is going, which is not the case with ETFs. ETFs are also highly liquid and easy to access, whereas the exit price with managed funds is estimated on a T+1 schedule, making it more complicated to redeem money from the fund. Managed funds also tend to have higher fees, unlike ETFs that only incur the commission charged by your broker.
2. What is the average return on a managed fund in Australia?
The average net return of a small share-managed fund after fees is 10.96% p.a, while large managed funds have reported a 7.48% net return after fees, Stockspot says.
3. Are ETFs cheaper than managed funds?
Many financial analysts compare index ETFs and actively managed funds, pointing to significant savings and returns provided by ETFs. This comparison is a bit unfair, though. The difference in the cost lies in the way the fund is managed (active vs passive), rather than the type of fund.
To compare the overall cost of an ETF vs a managed fund, one needs to look at the net of fee returns on the investment rather than the fees involved in investing in that particular fund.
