JARGON BUSTER: MANAGED FUNDS AND ETFS
Roy Davidson, 10 October 2019
Aside from investing directly in shares, if you want to invest in companies you have two main options; managed funds and exchange traded funds (ETFs). In this jargon buster we explain the differences between the two.
What are managed funds?
A managed fund is most likely the first thing that pops into your head when thinking about investment funds. As the name implies, these are funds run by a fund manager who attempts to outperform the market by picking the winners while avoiding the losers, thereby boosting returns for investors.
These funds are usually not listed on a stock exchange (though a number are) meaning you generally need to apply with the company running the fund in order to invest. The fund manager then takes your money, pools it with money from other investors, and puts it to work in the market. In exchange, you pay a management fee. A performance fee may also be charged on any out-performance over the benchmark.
Managed funds vary in scope from a pure New Zealand equities fund, for example, to a ‘balanced’ fund that includes a range of assets. The ‘style’ of the manager also varies, and can include a focus on companies with high growth prospects, high quality companies, and those offering good value.
What are ETFs?
ETFs are relatively new, being first introduced in the 90s. However, due to their low cost, their popularity has increased exponentially in recent years.
An ETF is a fund that is listed on an exchange (such as the NZX). This makes it simple for investors to buy and sell, with ETFs trading just like companies listed on the stock market.
ETFs track an underlying index (for example the NZX 50), but can also track a range of things including commodities like gold or oil, as well as bonds. For this reason, ETFs offer greater transparency around what you actually own, whereas many managed funds provide more limited disclosure.
As ETFs simply track an underlying index, the fees are typically much lower than a managed fund. However, there is no opportunity to outperform the benchmark.
Both types of fund provide diversification benefits
Both managed funds and ETFs can provide investors with a broad market exposure, bringing instantaneous diversification to a portfolio. This makes them especially suitable for those new to investing, and those with smaller sums to invest. Diversification within an investment portfolio is crucial as it reduces the risk of losing money; we don’t want to put all of our eggs in one basket.
A managed fund that invests in multiple asset classes can act as a one-stop shop. For example, a ‘balanced’ fund would likely include New Zealand and international equities, along with bonds, property and cash. ETFs tend to focus on only one asset class, and as such, multiple ETFs are usually required to put together a truly diversified portfolio.
In addition, both managed funds and, especially, ETFs can also enable investors to gain exposure to a particular theme or sector, but in a more diversified way. There really are more ETFs than you can shake a stick at. For example, those wanting to invest in the global technology sector can buy an ETF that comprises dozens of technology companies from around the world. Likewise, those looking to invest in a specific country, say India, can buy a diverse range of Indian companies via an ETF.