Exchange-Traded Funds vs Managed Funds

The investment landscape in Australia is evolving, with Exchange-Traded Funds (ETFs) and Managed Funds gaining popularity.

Managed funds remain a popular investment option in Australia, however, the continued growth of ETFs may eventually diminish the popularity of managed funds.

But how does one choose between investing in a managed fund vs ETF?

The article aims to differentiate Exchange-Traded Funds vs Managed Funds, including their investment strategies, cost structures, and the process of buying and selling. These insights may help you make educated investment decisions based on your financial goals and risk tolerance.

What are Exchange-Traded Funds (ETFs)?

Exchange-traded funds (ETFs) are open-ended investment funds that can be bought or sold like any share on a share market such as the Australian Securities Exchange (ASX). They are a low-cost way to earn a return similar to an index or a commodity, and they may help diversify investments and portfolios.

ETFs are available for a range of asset classes, including Australian shares, international shares, sectors of the Australian or international stock exchange, fixed income investments like bonds, precious metals, commodities, and foreign currencies.

Key Features of ETFs

Exchange-traded funds (ETFs) may be attractive investment options due to characteristics such as liquidity, low expense ratios, and the ability to track specific indices.

Diversification: ETFs offer investors the ability to diversify across various asset classes and within each asset class, as they hold a basket of different securities.

Passive Management: Passive fund management replicates the performance of a market or benchmark index rather than outperforming it. Most ETFs are designed to track specific indices, sectors, or commodities.

Liquidity: ETFs, traded on share exchanges, offer investors the flexibility to buy and sell units at market prices, facilitating easy entry and exit of positions.

Low Expense Ratios: ETFs offer cost-effective investment options with lower expense ratios and low management fees, making them attractive to investors.

ETFs in the Australian Market

In 2021, Australia’s ETFs industry experienced 44% growth, surpassing the global industry, with a current value of AUD$136.9 billion. One in seven Australians reportedly owns ETFs, the majority of whom are from Generations Y and Z.

240 ASX-listed ETFs were available as of January 2023. Most ETFs in Australia are passive investments such as index funds, which aim to replicate the performance of a specific market index.

The performance of specific ETFs can be tracked through financial news outlets, investment research websites, and the Australian Securities Exchange (ASX) or Cboe Australia (CXA) websites.

What is Managed Funds?

Managed funds pool investors’ money into a central fund managed by investment management firms to maximise returns over a set period. These funds may be open-ended, allowing new units to be created and cancelled as investors redeem.

Managed funds can potentially include financial assets, cash, or property titles and are overseen by professional fund managers who make investment decisions based on investors’ specific risks, goals, and needs.

Key Features of Managed Funds

Managed funds offer several key features, including active management, diversification, and the potential for outperformance based on fund manager expertise. Here are the highlighted features of managed funds:

Diversification: Managed funds provide exposure to a variety of assets and markets, both international and domestic, allowing investors to diversify their portfolios in a single trade.

Active Management: Professional money managers oversee the portfolio of shares, bonds, or other securities in a managed fund, making decisions to buy and sell assets based on the fund’s investment objectives.

Potential for Outperformance: The expertise of the fund manager may potentially lead to outperformance, as they make investment decisions to maximise returns over a set period.

Specialised Management: Investors benefit from the experience and knowledge of the fund’s manager in making the best investment decisions.

Managed Funds in the Australian Market

The managed funds industry in Australia is significant, with $4,571.5 billion in funds under management as of September 2023. The industry is regulated by the Australian Securities and Investments Commission (ASIC).

The industry is diverse, catering to both retail and wholesale clients with different objectives, financial circumstances, time horizons, and risk profiles.

For example, a report by Class indicates that more than half of the 20 most popular managed funds invested in by Self-Managed Super Funds (SMSFs) invest in global shares, bonds, or infrastructure. This indicates that SMSFs use managed funds to diversify their investments and gain exposure to international markets.

The market is dominated by funds management companies owned by life insurance companies and international financial groups.

Exchange-Traded Funds (ETFs) VS Managed Funds

When comparing an ETF vs managed fund in Australia, several key factors come into play, including investment approach, liquidity, costs and fees, transparency, and tax efficiency.

Investment Approach

ETFs tend to be passively managed, tracking a particular index or asset class. They are designed to offer diversification by mirroring the performance of the underlying index or asset class.

Managed funds, on the other hand, tend to be actively managed, with a portfolio manager making investment decisions to outperform an index or benchmark. This active management potentially leads to higher fees compared to ETFs.

Liquidity

ETFs are traded on share exchanges at market prices throughout the trading day, providing investors with the flexibility to buy or sell shares when the market is open.

Managed funds are typically less liquid, with investors being able to buy or sell units only at the end of the trading day.

Costs and Fees

ETFs generally have lower management fees compared to managed funds, primarily because they are usually passively managed. The lower costs make ETFs an attractive option for many investors.

Managed funds typically have higher fees due to the active management involved, which may impact the overall returns for investors.

Also, ETFs trade like shares, so there is no minimum investment size (other than your broker’s), unlike many managed funds, which have large minimums.

Transparency

ETFs usually provide a daily disclosure of their holdings, offering investors a high level of transparency. This transparency may potentially help investors make informed decisions based on the assets held within the fund.

Managed funds may disclose their holdings less frequently, making it more challenging for investors to have a clear view of the fund’s underlying assets.

Tax Efficiency

ETFs may minimise capital gains distributions through the creation and redemption processes, leading to greater tax efficiency. This investment strategy is not available for many managed funds, making ETFs a more tax-efficient investment vehicle.

Managed funds may pass along capital gains at the end of the year, potentially resulting in higher tax implications for investors.

When comparing ETFs vs Managed Funds, you’ll notice that they differ in their investment approach, liquidity, costs and fees, transparency, and tax efficiency. ETFs are often passively managed, more liquid, have lower costs, offer greater transparency, and are more tax-efficient compared to actively managed funds.

Making the Right Choice for Your Portfolio

When comparing managed funds vs ETFs, it is important to assess your personal preferences, investment goals, and risk tolerance. By considering these factors, investors may make more informed decisions when deciding between managed funds and ETFs in Australia.

Personal Preferences: Your investment preferences play a significant role in determining the most suitable investment vehicles. Factors such as the desire to outperform the market, willingness to own both index and actively managed funds, and the level of comfort with researching individual securities all influence the choice between ETFs and Managed Funds.

Investment Goals: Your investment objectives may include capital preservation, income generation, wealth accumulation, and growth. Some investors prefer equity-focused funds for long-term growth, while others prefer bond or dividend-yielding funds for income and stability.

Risk Tolerance: Understanding your risk tolerance, which is affected by age, finances, investment experience, and market volatility, is crucial.

Seek Financial Advice: Seeking professional financial advice before making investment decisions is highly valuable, especially considering individual circumstances. Research commissioned by CPA Australia and conducted by CoreData Research has shown that “approximately four in five advised Australians, either consumers or business owners, say professional advice has given them greater peace of mind about their finances, greater control over their financial situation, and improved financial security. ”

A financial adviser helps you match your investment goals with the right type of investment fund. For example, if you‘re seeking long-term growth you may lean towards equity-focused funds. However, if you’re prioritising income and stability, you might prefer bond or dividend-yielding funds.

Additionally, a financial adviser makes you aware of the potential pitfalls of investing without considering long-term trends or one’s risk tolerance. They provide thorough research and understanding of the various investment funds to help investors make more informed and considered decisions.

Summary: Exchange-Traded Funds vs Managed Funds

When it comes to Exchange-Traded Funds vs Managed Funds, both provide diversification by pooling money from many investors and investing across various asset classes, industries, and market segments. The similarities and key differences between the two are as follows:

Asset Ownership: ETFs and managed funds are structured as trusts, with the underlying assets owned by the trustee on behalf of the unit holders.

Trading Flexibility: ETFs can be traded on the Australian share exchange market throughout the trading day at the current market price, providing flexibility for investors comfortable with trading on the exchange. Managed Funds lack flexibility in intraday trading compared to ETFs, as they are not traded on the share exchange and pricing is determined at the end of the trading day.

Pricing: The pricing of ETF units is based on the current market price during the trading day. The pricing of managed fund units is not based on the current market price during the trading day.

Transparency: ETFs publish the net asset value (NAV) daily, allowing investors to track the performance of the underlying assets. Managed funds may not offer the same level of transparency as ETFs, as they may not publish the list of assets owned by the fund.

When comparing ETFs vs managed funds, it is important for Australians to regularly evaluate their investment choices based on changing market conditions and personal financial goals. Both investment options have their own characteristics that should be considered. Investors should consider factors such as fees, performance, instant diversification, transparency, and liquidity when deciding between the two options.

Ready to Build an Investment Portfolio? 

While investing may seem complicated and time-consuming, it doesn’t have to be that way with knowledge and expert guidance. Whether you’re young or old, it’s never too late to start investing, so you can achieve your goals.

Need investment advice? Newcastle Financial Planning Group can work with you to tailor your investment plan and build your portfolio. Our financial advice team can help you establish direction for your investments to achieve your financial and lifestyle goals.

Call us or book online to secure your consultation today!

 

References:

• https://www.rba.gov.au/publications/bulletin/2017/jun/6.html
• https://www.forbes.com/advisor/au/investing/etfs/
• https://www.rba.gov.au/publications/bulletin/2003/feb/3.html
• https://download.asic.gov.au/media/gnop4u2y/rep702-published-24-september-2021.pdf
• https://www.rba.gov.au/publications/bulletin/2003/feb/3.html
• https://www.cpaaustralia.com.au/-/media/project/cpa/corporate/documents/public-practice/public-practice-research/the-value-of-advice-research-report.pdf?rev=0c3ab7fa3f064c7e8588ff52650bc5b9
• https://www.superguide.com.au/smsfs/smsf-investment-popular-managed-funds