ETFs - Spring 2017  

Comparing ETFs and index mutual funds

  • Learn the main differences between ETFs and index mutual funds.
  • Comprehend why ETFs and passive products are growing in popularity.
  • Understand why a client might want exposure to one product over the other.
Comparing ETFs and index mutual funds

Exchange-traded funds (ETFs) have been gathering assets in ever larger numbers as investors continue to flock to passive products over actively-managed vehicles.

The increasing popularity of passive products like ETFs is evidenced by the most recent industry figures.

Consultancy ETFGI reports that ETFs/ETPs recorded a record level of net inflows in December 2016 of $65.3bn, marking the 35th consecutive month of net inflows. 

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The year as a whole was a record one as ETFs globally saw net inflows reach a new high of $389.3bn, surpassing the prior record of $372.3bn gathered in 2015, according to preliminary data from ETFGI’s year-end 2016 global ETF and ETP industry insights report.

As Claire Perryman, head of SPDR ETFs UK points out, the overall rise in passive investing has been driven by a number of factors which are common across both ETFs and index mutual funds. She cites three examples:

  • Investors who historically only invested in active are introducing complementary passive exposures to their portfolios alongside high conviction active funds e.g. adding a sector fund where an active manager is underweight.
  • Greater availability of exposures allowing investors to do much more with passive than historically e.g. precise bond exposures such as short duration, or factor investing through smart beta exposures.
  • Traditional futures investors looking beyond derivatives to ETFs.

For advisers it is important to know how ETFs differ from index mutual funds, another type of passive investment, so that they can understand why one product might be more suited to their clients over the other.

What both types of product have in common is they are passive forms of investing and ones that are growing in popularity among UK investors.

Much of the interest in passive investing from advisers and investors has been down to funds which track an index outperforming active managed funds.

Similarities and differences

Another factor has been the considerably lower costs attached to investing in passive products, with prices continually being driven down by industry giants iShares and Vanguard.

Andreas Zingg, head of ETF distribution management, Europe at Vanguard, notes: “The ETF industry’s rapid rate of growth indicates investors are increasingly considering ETFs as an alternative way to access markets.”

He suggests there are more similarities between ETFs and index mutual funds than there are differences.

“Both ETFs and traditional funds have a shared regulatory background, meaning they face similar restrictions in terms of what they can invest in and how,” he explains. 

“Both ETFs and traditional mutual funds fall into the category of pooled investment vehicles, which means the funds from many individual investors are pooled together, which gives investors certain benefits, including economies of scale and diversification.”

Intra-day trading

Asking those in the industry what is the main difference between an ETF and an index mutual fund and most point to the intra-day trading an ETF offers.

Ms Perryman believes some investors like the fact that as well as being able to create and redeem units at net asset value (NAV) like a fund, ETFs can be bought via a stockmarket throughout the trading day. 

“This secondary market for ETF shares means an investor can simply buy units of an ETF via their broker and receive a price immediately rather than having to wait until the end of the day for the NAV,” she explains.