Exchange Traded Funds (ETFs) vs Mutual Funds
Guest Post by Justwealth Financial Inc.
Most investors are aware of what a mutual fund is, but there is less general understanding about what an exchange traded fund (ETF) is. Much of the discrepancy can be explained by the fact that mutual funds have been around for more than 50 years longer than ETFs which were introduced a little over two decades ago. Mutual Funds and ETFs essentially compete against each other for attracting investor assets and with 50+ years of seniority, mutual funds hold a decisive edge in terms of number of products and total assets under management.
A mutual fund is an investment vehicle owned by many investors who pool their capital together for the purpose of investing in securities such as stocks, bonds, and other assets. Mutual funds are managed by professional money managers, who invest the fund’s capital and attempt to produce capital gains and income for the fund’s investors. A mutual fund’s portfolio is managed in accordance with the investment objectives stated in its prospectus.
Mutual funds are typically sold or recommended by licensed representatives of financial institutions or investment dealers, as well as directly through the mutual fund companies. Mutual funds are bought and sold at the Net Asset Value (NAV) price established at the end of every trading day by taking the closing values of each investment and dividing by the number of outstanding units or shares.
Most mutual funds are actively managed which means that they seek to generate an investment return that is better than the return of the fund’s benchmark. Benchmarks are typically representative indices such as the S&P/TSX Composite or S&P 500, or combinations of indices, depending on what is defined by its investment objectives.
Exchange Traded Funds
Like the name suggests, an ETF is a fund that trades on an exchange, such as the Toronto Stock Exchange. Similar to a mutual fund, an ETF typically owns a number of underlying assets, such as stocks or bonds, and shares are issued to investors for a pro-rata representative ownership.
ETFs are purchased very similarly to how shares in common equity are purchased. Any investor who has a brokerage account may purchase ETFs and will pay a transaction charge whether it is purchased directly by the investor or through a financial representative. The price of the ETF will be determined by supply and demand, but generally will trade very close to its NAV.
A major distinction between most ETFs and mutual funds is that the majority of ETFs attempt to replicate the performance of its underlying benchmark, rather than to try and beat it. Since the composition of benchmarks are readily available, it is relatively easy task to administer, and therefore providers of ETFs charge very low management expense ratios (MERs). This is in contrast to mutual funds which charge relatively large fees since they attempt to “outsmart” these similar benchmarks.
|Trading||Purchased through Mutual Fund company or dealer at daily NAV||Purchased on a stock exchange at prevailing market prices|
|Performance Objective||Attempts to beat the benchmark||Attempts to match the benchmark|
|Fees||High MER||Low MER|
|Transaction Costs||May contain purchase or redemption charges||Brokerage commission|
As an example between a mutual fund and a comparable ETF, we took the oldest mutual fund and oldest ETF that use the S&P/TSX Composite as their benchmark. According to data from Morningstar Direct and the respective websites of the manufacturer of each fund, we present the following as of April 30th, 2020:
|RBC Canadian Equity Mutual Fund||iShares Core S&P/TSX Capped Composite Index ETF|
|Inception Date||April 17, 1967||February 16, 2001|
|Benchmark||S&P/TSX Composite Index||S&P/TSX Composite Index|
|Number of Holdings||99||229|
|Most recent MER (Fees)||1.89%||0.06%|
|15-Year Performance (Annualized)||4.28%||6.09%|
Sources: Morningstar Direct, RBC, Blackrock
The benchmark return over the same ~15-year period was 6.08%. It should be noted that over time, MERs can change, fund managers can change, and benchmarks can change so further analysis may be required to draw any conclusions. In general terms, however, these results are typical of research studies that show after fees, ETFs provide a compelling alternative to mutual funds due to the significantly lower fees charged, particularly over longer periods of time.
** Full Disclosure: Justwealth holds the iShares Core S&P/TSX Capped Composite Index ETF in a number of our more than 70 portfolios
Investing in ETFs with Justwealth
Justwealth is an online portfolio manager, or “robo-advisor”, committed to providing “Justice” for the overcharged and underserved Canadian investor. Justwealth provides investment management services in an easy to use and convenient online format. A Justwealth Personal Portfolio Manager will work with you to create a well-structured investment plan, build appropriate portfolios of low-cost ETFs, and continue to manage your investments on a fully discretionary basis.
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