Exchange-traded funds, or ETFs, have become a popular investment option for those looking to diversify their portfolios and gain exposure to a variety of assets. ETFs are similar to managed funds in that they allow investors to pool their money together, but they differ in the way they are traded. 

Unlike managed funds, which only trade once a day after the market closes, ETFs can be bought and sold throughout the day on a stock exchange, much like regular stock. With ETFs, investors can choose from a wide range of options, including tracking a specific index, sector, commodity, or investment strategy. ETFs offer a number of benefits, including lower expense ratios compared to managed funds.

In this article, our expert financial advisors look at what an ETF is in more depth as well as highlight some of the pros and cons and examine whether it might be a good idea for you.

ETFs vs Managed Funds – What’s the Difference Between ETFs And Managed Funds?

There are some key differences between ETFs and managed funds:

1. Structure: A managed fund pools money from many investors to purchase securities. The fund is managed by a professional fund manager who makes investment decisions and runs the day-to-day operations of the fund. An ETF, on the other hand, is a type of fund that is traded on stock exchanges, just like individual stocks. ETFs are typically passively managed and track the performance of a specific market index.
2. Pricing: Mutual funds are priced once per day, at the end of the trading day, based on their net asset value (NAV). ETFs, being traded on stock exchanges, are priced continuously throughout the trading day and their price is determined by supply and demand.
3. Investment minimums: Managed funds often have higher investment minimums, which can make it more difficult for individual investors to get started. ETFs, however, can often be purchased in small quantities. 
4. Trading flexibility: ETFs can be bought and sold throughout the trading day, just like individual stocks. This gives investors the ability to respond quickly to market conditions or changes in their personal financial situation. Managed funds, on the other hand, are bought and sold at their NAV only once per day. But it can take days, weeks or months for the money to come back to the investor depending on the underlying investments. 
5. Cost: ETFs are generally less expensive than mutual funds due to their passively managed structure and lower overhead costs. This can make ETFs a more cost-effective option for investors, especially for those who plan to hold the investment for an extended period of time.

Now let’s look at some of the benefits and drawbacks of ETFs more closely.

The Benefits of ETFs

Investing in Exchange Traded Funds offers many benefits, particularly when compared to traditionally managed funds. Here are some of the key advantages of ETFs:

• Diversification: ETFs allow investors to gain exposure to a wide range of equities, market segments, or styles with just one investment. An ETF can track a broad range of stocks or aim to replicate the returns of a specific country or group of countries or different themes or sectors.
• Consistent pricing: The chance of ETF share prices being higher or lower than their actual value is low. ETFs trade throughout the day at prices close to the underlying securities and any significant discrepancies are usually corrected through arbitrage. Unlike closed-end index funds, ETFs are priced based on supply and demand and any price discrepancies are usually captured by market makers.
• Stock-like trading: Despite providing diversification benefits, ETFs are generally highly liquid and trade like a stock. The time to settle your trades for ETFs happens within 2 days of you making the trade through your broker. 
• Tax efficiency: ETFs tend to be more tax-efficient than mutual funds, as they realise fewer capital gains due to their passive management style. Managed funds, on the other hand, are required to distribute capital gains to shareholders, which is taxable.
• Low fees: ETFs, being passively managed, generally have lower expense ratios compared to actively managed mutual funds. This is due to a lack of management fees, shareholder accounting expenses, service fees, and load fees associated with managed funds.

The Drawbacks of ETFs

• Market or sector risk: The market or sector that your ETF follows could decrease in value, leading to a drop in the value of your ETF investment. 
• Currency risk: If your ETF invests in overseas assets, there is a possibility of changes in currency exchange rates affecting your returns. Some ETFs offer currency hedging, which eliminates this risk.
• Limited choices: Although there is a multitude of ETFs available, the selection may be limited compared to other investment options like managed funds, making it difficult for investors to find an ETF that precisely aligns with their investment goals.
• Liquidity concern: Some ETFs invest in assets that are not easily tradable, making it challenging for the ETF provider to issue or redeem securities at times.
• Tracking errors: The return of an ETF may not match the index or asset it is meant to track, due to differences in the assets held by the ETF, fees, taxes, and other factors. This can result in buying or selling at a price that is not equal to the indicative net asset value (iNAV).

Types of ETFs

There is a range of Exchange Traded Fund types, each with different focuses and different types of asset classes, sectors, and investment strategies.

Active and Index ETFs

Index funds make up the bulk of ETFs. These are ETFs structured to passively track a benchmark index, such as the S&P 500 or ASX 200. They’re often a choice for people who want to take a more passive approach to investing, as they average out the rising and falling of hundreds of stock options to reduce risk.

Active ETFs are similar but are instead managed actively by portfolio managers instead of passively by ETF managers. These ETFs offer the potential for higher returns, as your portfolio manager will actively make decisions on buying and selling as the market changes, but also come with higher fees as a result.

Stock ETFs

Stock ETFs (also known as equity ETFs) are ETFs that focus on specific groups of stocks, such as technology companies, healthcare companies, or even more abstract ones such as environmentally conscious companies. Other types of Stock ETFs include:

• Large-cap or small-cap stocks
• Growth or value stocks
• International or emerging market equities

Stock ETFs offer investors a way to gain diversified equity exposure without having to pick individual stocks.

Bond ETFs

Bond ETFs offer access to multiple fixed-income securities such as government bonds, corporate bonds, and municipal bonds in a single trade. They are designed to offer more liquidity than directly investing in individual bonds, thereby decreasing risk.

They are often used by investors looking for income, portfolio diversification, or lower volatility.

Commodity ETFs

Commodity ETFs allow investors to gain exposure to physical commodities such as gold, oil, natural gas, agricultural products, or even a basket of commodities. These ETFs typically invest in futures contracts or hold the physical commodity itself.

Popular examples include Gold ETFs, Oil ETFs, and Broad commodity index ETFs.

Commodity ETFs can be used as a hedge against inflation or geopolitical risk, but they often involve higher volatility and more complex tax considerations.

Sector ETFs

Sector ETFs focus on specific sectors of the economy, such as technology, healthcare, financials, energy, or consumer staples. They are useful for investors who want to overweight or underweight certain parts of the market based on economic trends or personal outlook, while limiting exposure to the risks involved with individual securities.

Are ETFs Right for You?

Exchange Traded Funds (ETFs) have become a popular investment option for those seeking to diversify their portfolios and gain exposure to a wide range of assets. ETFs are different from mutual funds in that they can be bought and sold throughout the day like a regular stock, and they have lower expense ratios and fewer broker commissions than mutual funds.

However, ETFs can also have higher costs compared to investing in a specific stock, lower dividends, and skewed leveraged ETF returns, which could lead to significant losses for inexperienced investors. 

At Focus Partners Australia, we can help you navigate these options and develop a comprehensive approach to your investments, super, and wealth management. We’re passionate about empowering our clients to have an exceptional lifestyle through a comprehensive approach to holistic advice, investments, super, and wealth management.

We have extensive experience helping:

• Patent Attorneys
• Lawyers
• Retirees
• Business Owners
• High Net Worth Individuals

Are you looking to buy ETFs in Australia? Our services have helped many of our clients build wealth, enjoy what they’ve worked hard for, and leave a legacy they can be proud of. Contact us today!