Are Your Mutual Funds on Auto Pilot?

A: An Exchange Traded Fund is a fixed collection of stocks that are bundled together to create a new investment vehicle (the Fund). This would allow an investor to buy a unit in the fund similar to any other mutual fund. The difference is that the ETF is listed on an exchange and trades while that exchange is open.

ETFs usually are created with stocks that have common characteristics, for example the DIAMONDS ETF tracks the Dow Jones Industrial Average and iShares Dow Jones US Energy Sector Index Fund tracks the performance of the Energy sector.

The companies that are included in an ETF generally meet certain minimum requirements for capitalisation and reporting requirements so there is a level of quality assurance that comes with an ETF.

The ETF will enable an investor to benefit from the diversification of owning many companies and will also allow one to take advantage of the positive or negative outlooks on market sectors or regions.

Q: How does an ETF differ from a Mutual fund?

A: The differences mainly are a result of how the vehicles are managed. A Mutual Fund is a pool of money that is managed based on an underlying strategy e.g.: Growth Fund vs. Income Fund. The Mutual Fund is actively managed within a specific asset class or strategy, therefore the manager seeks to outperform by using his judgment on what and when to buy or sell. There are mutual funds that are traded but are not necessarily ETF’s.

One example is the Savinvest India/ Asia Fund, which trades on the TT Stock Exchange and allows for investments primarily located in India.

ETFs on the other hand are not always managed and so may not offer any security selection within the fund. ETFs seek to replicate the performance of the sector or index so the securities are determined by the index or sector. So essentially you buy the basket of companies and own them as long as you hold the ETF.

The active vs. passive management also influences cost. Exchange traded Funds have lower expense ratios, or the annual costs of running the funds, than the vast majority of traditional mutual funds. Mutual Funds also carry sales charges or loads (with the exception of no load funds) while you will have to pay a commission to your broker to buy an ETF. The cost of buying an ETF is typically much lower than the sales charge on a Mutual Fund

Mutual Funds do not trade during market hours and are priced at the close of business. ETFs trade intra day and quotations can be gotten real time.

While typically mutual funds trade at their net asset value (market value of the funds net assets divided by the number of shares outstanding) ETF’s have the potential to trade above (at a premium) or below (at a discount) to its NAV. This is due to the fact that it trades like a stock or intra day and the increased demand for the ETF will drive the price above Net Asset Value (NAV) or supply force it below.

Q: Which are better?

Mutual Funds or Exchange Traded Funds?

A: That answer is dependent on your personality and financial goals.

Mutual Funds are attractive when you can find a manager that performs and the strategy of the funds is compatible with your overall financial plan.

The Mutual Fund allows you to have the money actively managed by a professional and therefore be rebalanced and positioned on an ongoing basis within the fund. A good analogy is a commercial flight. You buy a ticket get on the plane and leave the details to the crew .You get out at your destination and that’s it.

An ETF however is static so it requires you to have a more hands on approach. The sector or index in which the ETF is invested may out perform for a while but the ever-changing global market place dictates that the performance of the Index will also change.

To continue the analogy, in this instance you represent the flight crew. You are now flying the plane (or at least the co-pilot) and therefore are an integral part of the decision making process.

You therefore have to be cautious of your timing on entry and aware of the ongoing situation in the sector or market. This would prevent you from buying at what may be a bad time due to changing outlook in that sector.

The above mentioned sensitivity to future outlook also would allow you to buy in to for example the Energy or Technology sector when you believe these sectors are due for an upswing in their performance. So an ETF portfolio can be actively managed based on your risk tolerances and views of the markets in general.

The ETF enables you to target and limit your risk in a predetermined way. You have a clear idea of where your money is being invested so at the start you can diversify your portfolio among sector, country and market with very definitive amounts.

All advice offered here by Republic Securities Limited is of a general nature and is intended for guidance only. It is offered without any legal responsibility. You should always consult a financial advisor either at Republic Securities or elsewhere before making any investment decision.

If you have an investment question you would like to put to Republic Securities then send us an email at rslinfo@republictt.com. We cannot guarantee an answer to any question, but a selection will be put to our team of Investment Advisors to answer accordingly.