Exchange traded funds (ETFs) burst onto the investment scene in 2001 when Vanguard launched the first ETF in Australia. Since then they have become a popular alternative to managed funds. According to the Australian Securities Exchange’s (ASX) figures, more than $8.8 billion are held in ETFs in Australia.
So what are the pros and cons of the two different investment vehicles?
First, a small ETF lesson. ETFs typically track an index, which means their returns are meant to mimic the return of the index on which they are based. For instance, the Vanguard MSCI Australian Small Companies Index ETF aims to achieve the same return as the MSCI Australian Shares Small Cap Index, before fees and charges.
As the name suggests, ETFs are traded on a stock exchange like the ASX. In contrast, managed funds are not generally listed on an exchange.
As Michael Miller, financial adviser, MLC Advice Canberra, notes, there are two considerations in deciding between a managed fund or ETF.
“The first question to pose is whether you want an active or passive investment manager,” he suggests.
Active and passive management are different investment styles. “With an active strategy, a portfolio manager will make ongoing decisions about which investments to hold in a portfolio. A passive strategy means that the manager simply invests in a specific list of investments, such as the ASX 300, which is the largest 300 shares on the Australian share market,” Miller explains.
Currently in Australia, ETFs are only available for passive investment strategies, so if you want an active manager you will need to invest via a managed fund.
The second question Miller advises investors to ask is how often you intend adding funds to your investment.
“A managed fund will generally allow you to make regular contributions, without paying any transaction fees. To purchase an ETF you need to have a brokerage account, and you will pay brokerage for each transaction. You can usually find online brokerage for a minimum fee of $19.95,” he says.
According to Miller, an ETF usually has lower management costs than the equivalent managed fund, so you need to balance the lower management costs versus brokerage costs for an ETF.
For example, he says an investor who contributes $5,000 a quarter into a simple fifty/fifty split between Australian and international shares will face the following costs in the first year:
|Exchange traded funds||Managed funds|
|Costs as percentage of capital invested||1.28%||0.67%|
Says Miller: “the brokerage costs are slightly higher in this case because while there is one managed fund for international shares, an ETF investor needs to purchase two funds to have the same investment exposure.”
He explains that for the lower management costs of the ETF to outweigh the additional transaction costs, investors would need to add to their funds on a less frequent basis, or invest much larger amounts of capital.
Both ETFs and managed funds have their place in a portfolio, depending on the investor’s goals. It’s worth talking to an adviser before investing to ensure you choose the right product for your needs.