ETFs (Exchange-traded Funds) and Unit Trusts (also known as Mutual Funds) often get confused because they both offer diversified exposure to the market.
What exactly are ETFs and Unit Trusts and how do they differ? When choosing whether to invest in ETFs or Unit Trusts, it’s important to understand their key differences and what they mean for your investment strategy.
An ETF, or an Exchange-traded Fund, is an index-tracking investment tool that is traded in a public market. Indexes are composed of asset classes, such as stocks or bonds, that are typically focused on a particular segment of the market, such as technology, energy, or real estate. They may also focus on a particular geography, such as Japan or Emerging Markets.
ETFs follow these indexes to track the market’s volatility. ETFs are traded on the stock exchange just like a security and they are very popular: in 2016, 14 out of the 15 most active securities were ETFs, and only one was a stock: Apple.
An example of an ETF is the SPDR S&P500 ETF (ticker: SPY), that tracks the S&P500 index. Buying shares of SPY, an investor gets exposure to the performance of the S&P 500. Learn more about ETFs.
A Unit Trust, or Mutual Fund, is an actively-managed investment tool. Like an ETF, it has many securities beneath it, but the two differ in how the funds are created. With a Unit Trust, individual investors pool their money into a Unit Trust, and then the fund manager oversees the fund by investing in individual securities, such as stocks or bonds.
In turn, the investors of the fund earn proportional ownership of the fund. Investing in a Unit Trust is betting on the manager’s ability to pick the best securities, or “winners”, and therefore perform better than the market. Unit Trusts are bought and sold through private channels.
Below, we summarise the differences between ETFs and Unit Trusts: how they are sold and how they are managed. In practice, these differences typically lead to dissimilar overall returns. How? It comes down to their structure, how they’re managed, and the associated costs.
Buy/sell: Traded on a public market
Management type: Passively managed
Liquidity: Highly liquid (can be bought or sold like a stock)
Asset class composition: Constrained to asset class
Annual fees: 0.05%-0.7%
Entry fees: If purchased through a broker, $10-20 SGD per trade
Buy/sell: Sold through private channels
Management type: Actively managed
Liquidity: Usually not as liquid as ETFs (can have higher fees, and limited buying and selling)
Asset class composition: Can have diversified asset classes
Annual fees: 1.5%(median)
Entry fees: 3.0-5.0%
Figures refer to pure, plain-vanilla equity funds. Balanced and fixed-income funds tend to have lower annual management fees.
Data for “Unit Trust” comes from The Cerulli Report - Asian Distribution Dynamics 2015.
Because ETFs are traded on the stock market like a security, they are easily sellable, which can give you almost immediate access to your cash.
When selecting an ETF, though, it is very important to check its size, liquidity, and tracking error, as some of the more “niche” ETFs lose their liquidity feature by being too small and therefore don’t achieve good trading volumes.
Unit Trusts, on the other hand, are only available to buy and sell after the market closes each day. Additionally, Unit Trusts usually have associated entry and switching fees for buying and selling, which can make the investment more costly than an ETF.
ETFs typically track indexes of specific asset classes, whereas Unit Trusts can contain several different asset classes in a single fund. But that’s not to say that an ETF can’t be in a portfolio with other asset classes - it can!
Most major and minor asset classes, markets, and geographies are covered by one ETF or another. Plus, with the introduction of smart beta ETFs and alternative ETFs, such as the IQ Merger Arbitrage ETF, investors will start seeing more and more ETFs with multiple factors of exposure to various asset classes.
Unit Trusts provide the flexibility to build a portfolio of your choosing without being constrained to a specific tracking function. So, if you’re looking to invest in a specific niche that no liquid ETF covers at a given time, a Unit Trust may be the best way to create a portfolio that has the unique underlying securities you want.
Ultimately, an ETF offers diversified exposure to a particular asset class at a low cost, and Unit Trusts still can achieve the exposure, but at a higher cost. Unit Trusts are better suited to help an investor get exposure to a particular market niche where more liquid and cost-effective products are not available.
Investors who build portfolios with ETFs deploy a passive investing strategy. They’re more concerned with the broader picture of long-term returns for an asset class, and less concerned with beating the market by picking the best stocks.
Because an ETF tracks an index, its investment strategy is very clearly laid out by the choice of index and the execution is very cost-effective, as no decision-making is needed.
On the other hand, Unit Trust managers deploy an active investing strategy, which focuses on choosing which securities to buy and sell at any given time based on the future prospects of a specific asset (e.g. will Apple’s stock increase in price or decrease?). This is what’s commonly referred to as “stock picking.”
Recently, active fund management has come under scrutiny for its ineffectiveness at outperforming major indices, such as the S&P 500, over a long-term period, resulting in overall lower returns for investors.
According to the S&P Indices Versus Active Funds, as of December 2020, only 25% of active fund managers in the US managed to beat the S&P 500 Index in the last 5 years.
Unlike Unit Trusts, ETFs track indexes and so they don’t require a fund manager to select securities. This passive management allows ETF portfolio managers to charge less than their Unit Trust counterparts in management fees.
On the other hand, investing in Unit Trusts is usually inherently more expensive because of its focus on active securities selection.This approach requires more management, which incur higher costs that are then passed down to the customer.
These management fees include the frequent fees for buying and selling securities within the Unit Trust. Additionally, Unit Trusts usually carry distribution costs, as they’re not available on public markets. Part of these costs are usually included in the management fees, while part of them are charged as “entry” or “exit” fees. These fees are often referred to as “loads.”
Learn more about what it costs to invest.
It depends on what you want to achieve in your investment strategy. ETFs are more liquid, diversified, and usually come with lower management fees compared to Unit Trusts. But, Unit Trusts may still be suitable for those who prefer to invest in a particular market niche or select particular securities.
At StashAway, we use ETFs in every client’s portfolio: Their low costs don't cut into returns, their diversified exposure to the markets maximise returns at any given level of risk, and their liquidity and versatility give us the flexibility to face any economic environment. All of this ultimately helps our clients achieve their financial goals faster than with other investment products.
Want to know more? Here’s how we select our ETFs.
StashAway Malaysia Sdn Bhd (201701046385) is licensed by the Securities Commission Malaysia (Licence eCMSL/A0352/2018).