Investing Product Review

EXPLAIN: Managed Funds, Index Funds & ETF’s

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What is the difference between a managed fund, an index fund and an ETF?

Should you invest in managed funds, index funds or ETFs and why?

1Managed Funds 

A managed fund (or mutual fund in the US) is a professionally managed investment fund that pools money from many investors to purchase securities.

Wikipedia

Managed funds are arranged in a unit trust structure.

So as opposed to you buying shares directly from the Australian Stock Exchange (ASX) you buy units in a managed fund:

CHART: Managed Fund Structure

managed-fund-diagram

As an investor in a managed fund you have pooled your money with many other investors in a tax structure known as a unit trust. 

The unit trust is accounted for by fund administrators and all investment (buy / sell) decisions are made by professional fund managers.

A large unit trust could contain hundreds of thousands of investors each holding a number of units that corresponds to their interest in that managed fund.

The objective of professional fund managers is to beat the market index return, hence they trade actively in an attempt to achieve this – this is known as active management.

You usually select a managed fund to invest in based on the fund managers investment philosophy and the historical returns.

Pros (Managed Funds)

  • A simple way for investors to access a professionally managed diversified portfolio of investments
  • Economies of scale for fund managers as they can execute investment ideas for all investors
  • Fund administrator provides a complete tax report at year end

Cons (Managed Funds)

  • Investment costs tend to be high, upwards of 1% p.a.
  • Requires paper application and redemption
  • Pricing updated daily or weekly
  • Little transparency of underlying investment holdings
  • Takes a minimum of 5 days to enter and exit the fund

Useful Information (Managed Funds)

To see a list of the best performing managed funds available in Australia:

Financial Standard – Performance Tables

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2Index Funds

An index fund is an investment fund that is designed to track specified basket of underlying investments or index (for example the ASX 200 market index) and is bought and sold like a managed fund.

Index funds are also arranged in a unit trust structure.

So as opposed to you buying shares directly from the Australian Stock Exchange (ASX) you buy units in an index fund:

CHART: Index Fund Structure

index-fund-structure

As an investor in an index fund you have pooled your money with many other investors in a tax structure known as a unit trust. 

The unit trust is accounted for by fund administrators and all investment (buy / sell) decisions are made by index fund managers.

A large unit trust could contain hundreds of thousands of investors each holding a number of units that corresponds to their interest in that index fund.

The objective of index fund managers is to match the market index return, hence they trade to replicate the index – this is known as passive management.

You usually select an index fund to invest in based on the index the fund tracks, the costs and the historical returns.

Pros (Index Funds)

  • A simple way for investors to access an entire market index
  • Lower investment costs than actively managed funds
  • Economies of scale for index managers as they can execute investment ideas for all investors
  • Fund administrator provides a complete tax report at year end

Cons (Index Funds)

  • Requires paper application and redemption
  • Takes a minimum of 5 days to enter and exit the fund

Useful Information (Index Funds)

Vanguard is the largest index fund provider in the world. To see a list of their index funds available in Australia:

Vanguard – Index Funds

3ETFs

An exchange-traded fund (ETF) is an investment fund that tracks a specified basket of underlying investments or index and is bought and sold on the Australian Stock Exchange (ASX)

[could also be called an Exchange Traded Index Fund].

ETF’s are pooled funds, usually based on an index, that can be bough and sold on the ASX.

So as opposed to you buying individual company shares directly from the Australian Stock Exchange (ASX) you buy an ETF on the ASX:

CHART: ETF Structure

etf-structure

As an investor in an ETF you have a shareholding in a fund that is tracking a certain market index.

The ETF is accounted for by fund administrators, the market prices are managed by market makers and all investment (buy / sell) decisions are made by ETF fund managers.

A large ETF could contain hundreds of thousands of investors each holding a number of shares that corresponds to their interest in that ETF.

The objective of ETF fund managers is to match the market index return, hence they trade to replicate the index – this is known as passive management.

You usually select an ETF to invest in based on the index the fund tracks, the costs and the historical returns.

Pros (ETFs)

  • A simple way for investors to access an index fund on the ASX
  • Investment costs from as low as 0.05%
  • Live pricing while the market is open
  • Can easily buy and sell like any share (settlement in trade date + 2 days)
  • Updated holdings available on the ETF providers website

Cons (ETFs)

  • Have to pay brokerage costs to broker to trade on the ASX
  • Have to keep track of transactions for tax reporting

Useful Information (ETFs)

Here are some useful links for investing in ETFs:

Complete list of ETF’s available on the ASX

ETF Performance Table

Read why Warren Buffett prefers index funds to actively managed funds below…

  • The term index fund is now used to distinguish between an active fund management and a passive fund management.
  • Most ETF’s are index funds that are traded on the stock exchange (ASX)
  • Some newer ETF’s are showing some active characteristics – you can usually tell based on the investment costs (active funds are always more expensive)

Summary

  • Managed funds and index funds have the same tax structure but different investment styles;
  • ETF’s are simply index funds that are traded on the exchange;
  • For ease of transacting I prefer to invest in ETF’s, over unitized index funds or managed funds.

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The information on this blog and website is of a general nature only. It does not take into account your individual financial situation, objectives or needs. You should consider your own financial position and requirements before making a decision. We recommend you consult a licensed financial adviser in order to assist you with this.

 

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