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Managed funds and exchange-traded funds (ETFs) are two of the most popular long term investment options. Both can offer investors a convenient way to diversify their portfolios and earn long term returns. However, they do differ significantly in a few key aspects.

1. Managed funds vs ETFs - structure and management

Managed funds

Managed funds are also known as mutual funds or unit trusts. They are investment vehicles in which a fund manager pools money from multiple investors and allocates the funds to a diverse range of assets. These can include stocks, bonds, and other securities. Managed funds are typically overseen by a professional fund manager. This professional actively makes investment decisions on behalf of the investors, aiming to achieve the fund's objectives.

Exchange-traded funds (ETFs)

ETFs, on the other hand, are a type of fund that tracks the performance of a specific market index or sector. For example, an ETF might track the S&P 500, or the technology sector. Like managed funds, ETFs also pool investors' money and invest in a diversified basket of assets. However, instead of being actively managed, ETFs are passively managed and aim to replicate the performance of their underlying index or sector.

2. Trading and liquidity

Managed funds

Managed funds are typically bought and sold at the end of each trading day, with the fund's net asset value (NAV) calculated at the end of the day. This means that investors cannot trade managed funds intraday and must wait until the end of the trading day to buy or sell their units. Furthermore, managed funds may have minimum investment requirements and restrictions on the frequency of transactions.

ETFs

ETFs trade on a stock exchange in the same manner as individual stocks. As such, investors can sell and buy them during the trading day at prices determined by the market. This provides ETF investors with increased liquidity and flexibility compared to managed funds. Additionally, ETFs have no minimum investment requirements, making them more accessible to a wider range of investors.

3. Fees and expenses

Managed funds

Managed funds generally have higher fees and expenses than ETFs, primarily due to their active management. Investors can expect to pay management fees, also known as expense ratios, which cover the costs of managing the fund. Additionally, managed funds may charge sales loads, redemption fees, and other administrative fees, which can impact investors' overall returns.

ETFs

ETFs tend to have lower fees and expenses compared to managed funds thanks to their passive management. Most ETFs charge lower expense ratios, and many do not have sales loads or redemption fees. However, ETF investors do incur brokerage fees when buying and selling ETFs on a stock exchange, similar to trading individual stocks.

4. Performance and benchmarking

Managed funds

Managed funds are actively managed with the goal of outperforming a specific benchmark or index. However, studies have shown that a significant number of actively managed funds underperform their benchmarks over the long term. This is partly due to the higher fees associated with active management. Additionally, managed funds are more likely to deviate from their benchmark due to the active decisions made by the fund manager.

ETFs

ETFs aim to replicate the performance of their underlying index or sector, rather than outperform it. As a result, the performance of an ETF is generally more predictable and closely aligned with its benchmark. Due to their passive management, ETFs tend to have lower tracking errors, which is the difference between the fund's performance and the performance of its benchmark.

5. Taxation

Managed funds

Managed funds are subject to capital gains tax when the fund manager buys and sells securities within the fund. These transactions can generate capital gains, which are then distributed to the fund's shareholders. Investors are required to pay taxes on these capital gains distributions, even if they have not sold their shares in the fund. This can result in a tax liability for investors, which can affect their net returns.

ETFs

ETFs, on the other hand, generally offer more tax efficiency compared to managed funds. Investors typically incur capital gains tax only when they sell their ETF shares, allowing them to defer taxation until they choose to exit their investment. Additionally, ETFs benefit from an in-kind creation and redemption process, wherein authorised participants exchange a basket of the underlying securities for ETF shares and vice versa.

This process minimises taxable events within the ETF, as it generally does not trigger capital gains distributions. Consequently, ETFs can help investors better manage their tax liabilities and potentially enhance their after-tax returns compared to managed funds.

Summary: managed funds vs ETFs

Managed funds and ETFs offer investors a convenient way to diversify their portfolios. When it comes to choosing between the two, this is the guts of what you need to know:

1. Structure and management: Managed funds are actively managed by fund managers who make investment decisions with the aim of outperforming a benchmark index. ETFs, in contrast, are passively managed and track a specific benchmark index.
2. Trading and liquidity: ETFs are traded on stock exchanges like individual stocks, allowing investors to buy and sell throughout the trading day at real-time prices. Managed funds, however, are only priced and traded once a day, at the end of the trading day.
3. Fees: Managed funds typically have higher fees due to the costs associated with active management and research. ETFs generally have lower fees as they passively track an index and require less hands-on management.
4. Performance and benchmarking: Managed funds, which are actively managed by fund managers, aim to outperform benchmark indices (but often don't). ETFs, which are passively managed, track specific benchmarks, providing lower fees and broad market exposure.
5. Tax efficiency: ETFs are generally more tax-efficient due to their unique in-kind creation and redemption process. Managed funds may incur higher capital gains taxes for investors as the fund manager's buying and selling of securities can create taxable events.

Overall, the choice between managed funds and ETFs depends on your investment objectives, risk tolerance, and preference for active or passive management. As always, invest for the long term and happy investing!