First of all, it needs to be said that mutual funds and exchange traded funds (ETFs) are collective investment vehicles which are in many jurisdictions regulated within the same regulatory framework. This means both kinds of products are different ways to deliver an investment strategy to the investor.
The key differences between a mutual fund and an ETF are related to their product structure, buying and selling of shares, transparency, and fees and expenses:
1. Buying and Selling of Shares
The shares of mutual funds are normally bought and sold only once a day, at the fund’s net asset value (NAV). While the NAV is calculated at the end of the trading day, a buy or sell order needs to be placed until the so-called cut off time, which is normally in the morning of the same trading day. If the investor misses the cut off time, the order will be executed one day later. This means that investors do not know the actual price they pay or receive for their fund shares until the transaction is closed.
Conversely, ETFs trade like stocks on an exchange. This means every investor can buy or sell the respective shares of an ETF throughout the trading day at market prices, which may fluctuate during the day since the development of the underlying securities of the ETF are evaluated in real-time. Despite the ongoing pricing, there is an NAV calculated for every ETF at the end of each trading session.
Given the respective product structure, the managers of a mutual fund have to deal with incoming/outgoing cash from the daily transactions of investors. While the managers of ETFs normally don’t have to deal with any cash flows since they are getting the optimal basket of securities delivered from the authorized participants when investors bought shares of the respective ETF, or they deliver a basket of securities to the authorized participant if there were more sell orders.
2. Transparency
To enable this “cash free” creation and redemption process and a competitive pricing on exchange most ETFs publish their complete holdings every trading day. This means that any investor does so knowing exactly what the holdings of the ETF are.
Conversely, mutual funds publish their full holdings in most cases only twice a year (in the annual and semi-annual report). This means the investor is holding a black box, as (active managed) mutual funds are very reluctant when it comes to detailed publication of their holdings. With regard to this, the rise of active ETFs may lead to an increasing number of semi- or even non-transparent ETFs around the globe.
In addition, it needs to be said that investors in passive ETFs and index-tracking mutual funds do know how their ETF/index fund did at the end of a trading session by looking on the respective index, while the performance of active managed mutual funds and ETFs can differ widely from the results of the underlying market.
3. Fees and Expenses
Mutual funds typically have a higher total expense ratio compared to ETFs since active management is more expensive than passive management as it involves more data and analysts to prepare the decisions for the portfolio manager. In addition to this, the fees and expenses of mutual funds often include expenses for fund distribution which are paid to financial advisors or the respective brokerage platforms.
Since ETFs are bought and sold via an exchange, there are no fund distribution charges included in the general management fees. As a result, ETF investors are paying a charge, the so-called spread, when buying and selling shares of an ETF instead of a recurring fee.
What is with the Management Style?
In the good old days it was a given that ETFs were passive products which followed an index, while mutual funds were actively managed products which tried to beat their benchmark based on discretionary decisions made by a fund manager.
These assumptions were never fully right since index-tracking mutual funds are also passive products and have a long history.
More recently we’ve seen that asset managers are launching more and more actively managed ETFs, which means the former two worlds of ETFs and mutual funds are converting in the direction of ETFs. As a result, investors around the globe can nowadays choose from a broad selection of active and passive products in both kinds of distribution wrappers.
While some market participants still see a clash of cultures, I see a lot of opportunities for all kind of investors, as the launch of active ETFs widens the spectrum of choices for investors who prefer ETFs over mutual funds and brings down the overall costs for all investors.
This article is for information purposes only and does not constitute any investment advice.
The views expressed are the views of the author, not necessarily those of LSEG Lipper or LSEG.
