A common question that we get from new investors is ‘should I invest in equities or ETFs?’. Investors tend to conflate asset classes and investment products. And this isn’t surprising. The investment industry is in the business of selling products. And marketing works. Many investors believe the solution to all their problems is finding the right product.

There are a variety of ways to access different asset classes. And asset management companies are getting smarter about the ways that they collect funds. The investment product landscape keeps growing in breadth and offering more and more choice for investors.

We recently received a question from an Investing Compass listener who was interested in getting access to Barrow Hanley’s Global Share Fund. The fund is available as a managed fund and an ETF (ASX: GLOB).

Her question was – what’s the difference? It’s a good question.

How to choose the investment product that is right for you

 

Investment products should be chosen based on the circumstances and preferences of each investor. Although the breadth of investment products can seem overwhelming, it offers investors choice that may help with return outcomes. 

A good place to start is a simple definition. An exchange traded fund (“ETF”), an exchange traded managed fund (“ETMF”) and a managed fund are all collective investment vehicles. It is a way for an investor to get access to a basket of underlying securities and earn the return of that basket of securities. Those securities could be cash, bonds or shares. Or a mix of all of them.

In some cases there are multiple products that track that exact same pool of assets. That is the case in the question from the Investing Compass listener. The Barrow Hanley’s Global Share managed fund and ETF gives an investor exposure to the exact same pool of assets. The reason a fund manager issues multiple investment products that track the same assets is because they want to reach as many investors as possible and cater to their preferences.

Getting access to a managed fund generally requires investing through a financial adviser or filling out paperwork. This is a huge deterrent for investors who can easily access products available through a brokerage account that trade on an exchange. Offering more choice brings in more money for the manager. More money means more management fees collected.

As an investor, the benefits of an ETMF are non-existent initial investments and quick access to your funds. The unlisted version returns investor funds within 5-7 business days while the listed version settles 2 days after the trade date. Just like stocks and ETFs.

However, the ability to use a brokerage account to access the ETMF comes with brokerage fees. These transaction costs may make a difference if an investor is trading often.

Below is an overview of considerations for investors when choosing the investment vehicle that will provide exposure to a desired asset class. It is worth noting that there are reasons an investor would use different products within their portfolio. For example, you may choose to invest in Australian equities directly but may get international equity exposure through an ETF.

ETF chart

Transaction costs

Transaction costs eat into investment returns. If not managed, they can make a significant difference. Listed vehicles (Equities, ETFs and ETMFs) incur brokerage every time you buy or sell. This is a key consideration for investors that are trading frequently and / or investing or raising money frequently.

If you are investing frequently—whether that is with every pay cheque, or you are breaking a lump sum into pieces to dollar-cost average (DCA), a managed fund may be a better option. If you are investing infrequently or in lump sums, it broadens your option to investments that incur brokerage.

Managed funds (unlisted): May suit lower balances and frequent additional investments

Equities, ETFs, ETMFs (listed): May suit lump sums

Trading flexibility

Trading flexibility is important to some investors who would like the option of buying or selling assets frequently. Managed funds are unlisted, and a unit price is struck each day. What this means is that intra-day trading is not available. That is not the case with ETFs, ETMFs and direct equities, all of which are listed on an exchange.

Ultimately, trading flexibility should not be a significant consideration for long-term investors. Having flexibility to trade intra-day is not a priority over a long-time horizon. Frequent trading often leads to poor outcomes for investors.

Managed funds (unlisted): lower flexibility, prices once a day. Suitable for long-term investors.

Equities, ETFs and ETMFs (listed): higher flexibility to trade intra-day.

Minimum investment

Minimum investments for listed vehicles are effectively non-existent—you are able to purchase one unit of a stock, ETF or ETMF, and that will be the minimum to invest. However, this does not always make sense. Brokerage can have a big impact on your investment returns. Being able to buy a share for $3 does not mean you should purchase one unit for $3 and pay $10 in brokerage. Therefore, logical minimums should be imposed to ensure the amount of units you are purchasing makes sense.

For unlisted assets like managed funds, minimum investments are decided by the manager. Minimum investments can differ greatly between providers, with some managed funds starting at $500, and others with $100,000 initial minimum investments. For lower minimum investments, you can access funds through platforms in Australia.

Managed funds (unlisted): Dependent on the provider. Starting from $500

Equities, ETFs and ETMFs (listed): No minimums, but important to ensure that the investment amount makes sense for the brokerage paid.

Behavioural risks

Behavioural risks reflect our tendency as humans to act emotionally during volatility. We are driven by fear and greed, which is formula for buying at the top of the market and selling at the bottom. Both individual and professional investors create elaborate models and theories designed to dictate when and why to buy or sell a security. Despite these models there is still a high probability that an investor will panic when the market is going down and fear missing out on profits when it keeps climbing.

Behavioural risk

These actions have been shown to be to the detriment of the returns an investor achieves. This is called the ‘behaviour gap’—the gap between an investment return and the return an investor gets in the same time period. Constantly switching between investments and assets due to emotional responses has been proven to reduce returns for the majority of investors. My colleague covered this topic in a recent article on Morningstar’s Mind the Gap study.

The Morningstar fair value estimate is designed to prevent these types of behavioural mistakes. Changes in security prices do not impact the fair value estimate but do change the Morningstar Analyst Rating, which is inversely impacted by the price movement.

Successful investing means blocking irrelevant information and having the strength to stick to the plan and resist the urge to follow the herd. Some investments promote this, whilst others encourage overtrading.

Managed funds have a higher barrier to trade—this is called a ‘speed bump’, which can encourage you to think twice before making a transaction. They price once a day, which means that you do not see intra-day volatility like you do with listed assets. Most managed funds also require paperwork to redeem assets, which acts as a physical speed bump, where investors may think twice about making a transaction because of the time and effort taken to make it.

We covered the downside of ETFs and other listed assets in our Investment Compass episode The case against ETFs.

Listed assets are a little different—these barriers are not as high and you are able to freely trade between market open and close.

Managed funds (unlisted): higher barriers to trade and priced once a day, protects against behavioural risks

Equities, ETFs and ETMFs (listed): priced during market open and close, little to no barrier to trade and protect against behavioural risks