Etfs: Managed Investments Or Not?

Exchange-traded funds (ETFs) and managed funds are both types of investment schemes. They are similar in that they are both relatively low-cost and low-risk ways to invest in a variety of assets, including stocks, bonds, real estate, and commodities. However, there are some key differences between the two. ETFs are bought through a brokerage account and traded like stocks on an exchange market, whereas managed funds are actively managed by asset managers who use your investment to buy and sell shares in different companies. ETFs tend to be passively managed, tracking a market index, while managed funds may incur brokerage costs for more frequent investments.

Are ETFs Managed Investments?

ETFs are a type of managed investment scheme

Exchange Traded Funds (ETFs) are a type of managed investment scheme. Managed investment schemes are also known as 'schemes' or 'pooled investments'. In a managed investment scheme, multiple investors contribute money and get an interest in the scheme. The money from different investors is then pooled together and is often from hundreds or thousands of investors.

ETFs are a form of managed fund, which are actively managed by asset managers. When you invest in a managed fund, you purchase a share in a company that holds assets in a variety of companies. The asset managers use your investment to buy or sell more shares in different companies. You then receive returns based on how well these shares perform in the market.

ETFs are bought through a brokerage account and trade like stocks on the exchange market. Each ETF contains a basket of different assets, which can include stocks, bonds, real estate, infrastructure, cash, and commodities. ETFs are typically passively managed, meaning they track a market index. For example, the S&P ASX200 market index tracks the top 200 Australian companies.

ETFs are more tax-efficient and lower-cost than other managed funds. They are also more suitable for investing smaller amounts more frequently as they do not incur brokerage costs. However, they may not be as effective at avoiding market bumps as actively managed funds.

ETFs are bought through brokerage accounts

Exchange-traded funds (ETFs) are bought through brokerage accounts and traded on a stock exchange. They are a type of managed fund or investment scheme, but differ from other managed funds in several ways.

Firstly, ETFs are more accessible to the average investor. While managed funds require investors to frequently invest smaller amounts of money, ETFs can be purchased with a single share purchase. This makes them a good option for those who don't have a large amount of capital to start with.

Secondly, ETFs are passively managed. This means they track a market index and don't have a fund manager actively trying to avoid market fluctuations. In contrast, managed funds are actively managed by asset managers who use investors' money to buy and sell shares in different companies. The returns investors receive from managed funds are based on how well these shares perform in the market.

Thirdly, ETFs are more tax-efficient and lower-cost than managed funds. While managed funds may be better for investing smaller amounts more frequently due to the lack of brokerage costs, ETFs offer the opportunity for your money to accumulate market gains more quickly.

Finally, both ETFs and managed funds allow investors to diversify their portfolios by investing in a variety of companies at once, rather than putting "all your eggs in one basket". This minimises the risk to your investment.

ETFs are passively managed

Exchange-traded funds (ETFs) can be passively or actively managed. Passively managed ETFs are a popular strategy among investors who prefer a long-term, buy-and-hold approach to investing their money.

Passive ETFs seek to replicate the performance of a designated index by holding the assets listed on the index. They mirror the holdings of a designated index—a collection of tradable assets deemed to be representative of a particular market or segment. Passive ETFs are not actively managed by a fund manager, who makes decisions on the underlying assets in an attempt to beat the market. Instead, passive ETFs follow a rules-based approach, tracking a particular benchmark or asset class. This means investors gain exposure to entire markets represented by these indexes.

Passive ETFs offer several advantages over actively managed funds. They offer lower expense ratios, increased transparency, and greater tax efficiency. Passive ETFs are also more cost-efficient, with lower management fees, as there is no active manager trying to beat a benchmark. Passive ETFs also have lower turnover, resulting in fewer transaction costs and realised capital gains.

However, passive ETFs also have some disadvantages. They are subject to total market risk, lack flexibility, and are heavily weighted towards the highest-valued stocks in terms of market cap. They also have limited ability to adapt to changing market conditions or adopt defensive measures during a sell-off.

ETFs are more tax-efficient and lower-cost than managed funds

Exchange-traded funds (ETFs) are a type of managed investment scheme. In a managed investment scheme, multiple investors contribute money, which is then pooled together and operated by a fund manager.

ETFs are considered more tax-efficient than managed funds for two main reasons. Firstly, ETFs have a unique mechanism for buying and selling. They use creation units that allow for the collective purchase and sale of assets in the fund. This means that ETFs usually don't generate capital gains distributions, and therefore don't incur the tax effects that managed funds do. Secondly, most ETFs are passively managed, which creates fewer transactions because the portfolio only changes when the underlying index it replicates changes. Actively managed funds, on the other hand, experience taxable events when selling assets within them.

ETFs are also considered lower-cost than managed funds. The average expense ratio for an ETF is less than the average for a mutual fund. Additionally, ETFs offer greater transparency and liquidity. ETF holdings can be viewed daily, while mutual funds only disclose holdings every quarter. ETFs can also be traded throughout the day, whereas mutual fund shares can only be bought or sold at the end of a trading day.

It is important to note that there are exceptions to the tax efficiency of ETFs. For example, certain international ETFs, particularly emerging market ETFs, may be less tax-efficient due to restrictions on in-kind deliveries of securities. Leveraged/inverse ETFs have also proven to be relatively tax-inefficient due to their use of derivatives.

ETFs are more complex and risky than other managed funds

Exchange-traded funds (ETFs) are more complex and riskier than other managed funds. While they are considered low-risk due to their low cost and diversification benefits, they are still subject to unique risks and complexities, especially in the case of more speculative ETFs.

One of the biggest advantages of ETFs is that they trade like stocks, allowing investors to buy and sell during market hours and place advanced orders. However, this also means that investors may incur trading fees, which can quickly add up and impact investment performance. These fees are not typically associated with other managed funds, such as no-load mutual funds, which are sold without a commission.

ETFs are often lauded for the diversification they offer, but it is important to note that they are not immune to volatility. The potential for large swings depends on the scope of the fund, with ETFs that track specific industries or sectors being more volatile than those that track broad market indices. International or global ETFs also carry the additional risk of economic and social instability in the countries they follow.

Certain classes of ETFs, such as leveraged and inverse ETFs, are significantly riskier than other modes of investment. Leveraged ETFs tend to experience value decay over time, even as the underlying index thrives. Inverse ETFs move in the opposite direction of their reference or benchmark, and they also decay in value over time due to their structure.

Another complexity of ETFs is the potential for capital gains distributions, where capital gains are distributed to shareholders, creating a tax liability for the investor. Investors may need to incur additional fees to reinvest these distributions.

Finally, ETFs may offer less diversification than other managed funds in certain sectors or for foreign stocks, as investors may be limited to large-cap stocks due to the narrow group of equities in the market index.

In summary, while ETFs offer benefits such as low costs and diversification, they also come with unique risks and complexities that make them more complex and riskier than other managed funds.

Frequently asked questions