Exchange Traded Funds, Unlisted Managed Funds and Listed Investment Companies (LICS)
The main choice for an index fund investor is between Exchange Traded Funds, Unlisted Managed Funds (some of which can be bought and sold via the ASX mFund service) and Listed Investment Companies (LICS).
ETF’s and LIC’s can be bought and sold via the ASX like any other companies shares, some managed funds can be bought and sold via the ASX mFund service.
Across these categories there are actively managed and passive options, with the difference between the two something of a continuum.
Investment funds are investment vehicles that pool money from many different investors to increase investors buying power and diverse investors holdings. This allows investors to add a substantial number of securities to their portfolio for a much lower price than purchasing each security individually.
Examples of unlisted managed index funds include:
· Vanguard Index Australian Shares Fund
· Barclays World ex-Australia Equity Index Fund
Examples of listed exchange traded index funds include (for a full list refer to this article):
· SPDR S&P/ASX200 Fund (stock code STW)
· iShares MSCI Emerging Markets (stock code IEM)
Legal Structure of Managed Funds
Managed funds can typically be broken down into two types.
Open Ended Funds
Most managed funds are open-ended funds, with purchases and sales of fund shares take place directly between investors and the fund company. There’s no limit to the number of shares the fund can issue; as more investors buy into the fund, more units are issued. There is a daily valuation process at the end of the business day to determine the net asset value of each investors units. The value of the individual’s units is unaffected by the number of units on issue.
Close Ended Funds
Mainly ASX LIC’s (listed investment companies) these funds issue only a specific number of shares and do not issue new shares as investor demand grows. Prices are not determined by the net asset value (NAV) of the fund, but are driven by supply and demand and often at a premium or discount to the net asset value of the fund.
Legal Structure of ETFs
An ETF is bascially an open ended managed fund, with shares attached to units which can be traded on the stock exchange.
ETFs offer greater flexibility than managed funds when it comes to trading. Purchases and sales take place directly between investors and the fund. An ETF, by comparison, is created or redeemed in large lots by institutional investors and the shares trade throughout the day between investors like a shares.
Like shares, ETFs can be sold short, which is interesting to traders and speculators, but of little interest to long-term investors. ETFs are priced continuously by the market, and there is the potential for trading to take place at a premium or discount to the actual NAV.
Due to the passive nature of indexed strategies, the internal expenses of most ETFs are considerably lower than those of many managed funds. ETF’s with the lowest fees charge about 0.15%, while those with the highest expenses ran about 1.19%. Managed funds vary from 1% up to even 4% or more including other charges.
Managed funds can have entry and exit fees attached, and there is usually a spread payable between the purchase and the sale price, but there is no brokerage.
ETF’s attract a brokerage charge which may hurt frequent smaller purchasers, but there are no entry and exit fees and there is also spread payable also between the purchase and the sale price.
Tax Advantages and Disadvantages
Index linked managed funds and ETF’s are more tax efficient than actively managed funds because they don’t turnover their portfolio holdings as often and trigger capital gains tax consequences.
Managed Funds and ETFs have to distribute all of their income to investors, whereas listed investment companies can retain some of their income from the underlying investment portfolio which should result in an equivalent increase in the share price – which is taxed as a capital gain.
ETF liquidity is not related to its daily trading volume, but rather to the liquidity of the stocks included in the index. One risk of ETF’s is that liquidity can dry up in severe market conditions although most ETF’s performed very well through the GFC.
ETF and Managed Fund Survivability
A lot of ETFs (especially in the US) and managed funds are started up and then shut down for a number of different reasons, but usually because they could not attract sufficient funds. Investors in fund that is shut down could suffer some capital loss.