Unit trust vs ETF
Unit trusts and Exchange-Traded Funds (ETFs) are often confused as both are investment vehicles designed for investors to gain access to a basket of individual securities. Unit trusts, otherwise known as mutual funds, and ETFs are also broadly known as Collective Investment Schemes (CIS).
The products invested by these vehicles can vary widely from stocks, bonds, money market instruments to alternative assets, as determined by the fund manager. Although some consider ETF a subset of unit trust, it has certain characteristics that makes it different in nature. Read on to find out what they are.
What is ‘unit trust’?
Known as ‘mutual fund’ in Asia and in the United Kingdom, it is a pool of money from different investors. A fund manager uses this fund to invest in assets to generate profits for investors.
Investors put in a set amount of cash for the fund manager to buy an equivalent value of units or ‘shares’ of the fund. Traditional mutual fund managers use the pool of money from their investors to trade stocks in the fund portfolio.
The mutual fund tallies up the value of everything it owns and divides it by the number of units that exist. That would be the ‘unit price’ of the fund, or the NAV.
If you want more ‘shares’ or units of the fund, you will have to put in more cash. To liquidate or to redeem your share of the fund, you’ll have to sell your units of the fund according to the fund’s unit price.
Mutual funds, as with most investments, require a longer-term investment horizon to yield results, given there are potential fees for investing in unit trusts. To get a more comprehensive understanding of unit trusts, go here.
What is an ETF?
An ETF is also a pooled investment vehicle and as the name Exchange-Traded suggests, this type of fund is traded on an exchange just like stocks.
Investors who buy Unit Trusts or ETFs effectively own the vehicle that purchase the underlying financial product (say in stocks/bonds/securities), without the technical ownership of the shares in a company.
The main difference is that exchange-traded funds (ETFs) are traded like a stock throughout the day on a stock exchange. As a result, ETFs have a bid-ask spread, allowing investors to trade them regularly just like how one would trade stocks.
Unit trusts trade at the Net Asset Value (NAV) of the fund, which is based on the valuation point of the fund, which could span from daily, monthly or quarterly closing, and hence is more suitable for longer-term investors who do not need intraday liquidity.
Types of unit trusts
There are two legal classifications: open-ended funds and closed-end funds. The former has no limit to the number of shares that can be issued. The latter issues only a specific number of shares and does not follow NAV pricing.
The oldest and most common open-ended funds are fixed income or bond funds, equity funds and balanced funds. Here is a brief overview of each type that is available in Singapore.
1. Fixed income or bond fund
invests mainly in government bonds, corporate bonds and debt instruments, such as mortgage-backed securities.
2. Equity fund
invests mainly in the stocks of listed companies.
3. Balanced fund
combines higher risk equities, lower risk fixed income securities and cash in order to maintain a balance of both capital growth and regular income for investors
4. Exchange traded fund (ETF)
tracks or replicates the performance of a benchmark index.
5. Index fund
invests in a range of companies that closely match companies comprising a particular index. Index unit trusts and ETFs are designed to closely track benchmark indexes passively at low cost.
6. International equity fund
invests in shares of listed companies according to geographical mandate.
7. Money market fund
invests in low-risk but highly liquid investments, such as short-term debentures, short-term money market instruments and placements in short-term deposits.
8. Real Estate Investment Trusts (REITS)
invest in real properties, usually prominent commercial properties.
9. Islamic unit trust / Shariah fund
invests based on Islamic principles, which means the investments can only be made in Shariah-compliant securities that are not involved in non-halal businesses.
Types of ETFs
1. Broad-market ETF
tracks indexes that cover all or a large part of the stock market, such as the S&P 500
2. Sector ETF
invests in stocks within a particular sector of the market or industry
3. Dividend ETF
invests only in dividend-paying stocks
4. Style-based ETF
focuses on growth or value stocks
5. Commodity ETF
uses futures or other derivatives to invest in commodity markets
6. Currency ETF
focuses on foreign currencies
7. Bond ETF
as the name suggests, it invests in bonds that can cover the entire market or in specific sectors
Are unit trust and ETF alternative investments?
No. Whether they are alternative investments depend on the underlying asset class of the Unit Trust or ETF. For example, a SPDR S&P 500 ETF is an Equity based investment, whereas a Unit Trust such as Salzworth’s Global Currency Fund (which does FX Algorithmic Trading), is considered an Alternative Investment.
Click here for a more in-depth reading on alternative investments.
Similarities of unit trusts and ETFs
1.Both pay dividends
Exchange-traded funds pay out the full dividend that comes with the stocks held within the funds. Most ETFs do this on a quarterly basis on a pro-rata basis. For Unit Trusts, the dividend payout frequency depends on the underlying asset and Fund Manager’s decision.
2.Both have fees and charges
All ETFs pay certain charges including fees that the fund manager, trustee and other parties charge to the ETF. While these fees are generally low, they will still affect your returns.
There are usually no sales charges, but you should still find out about transaction charges such as brokerage charges and clearing fees.
3. Capital is usually not guaranteed
As with any investment, there is always a certain amount of risk and both usually do not guarantee the principal.
How are unit trust and ETF different?
1. Frequency of trading/subscription
For ETFs, you can trade them anytime (intraday) you want when the market is open. Buying and selling can be done multiple times within the same day. In a mutual fund, you would have to wait until after the close of trading (valuation point) or a stipulated subscription timeframe as determined by the Fund Manager.
2. Regularity of holdings disclosure
Holdings in an ETF are disclosed on a regular, frequent basis. Mutual funds disclose their holdings as stipulated by their regulatory bodies.
3. Premiums and discounts
When you buy or sell a mutual fund at the end of the day, you transact exactly at its stated Net Asset Value (NAV), so you always get a fair price. There are mechanisms that keep ETF share prices in line with their fair value, but they are not perfect.
At any given moment, an ETF might trade at a premium or at a discount to its NAV, given they are designed to allow investors to trade them regularly, especially intraday.
Investors must also pay the bid-ask ‘spread’ when buying or selling ETFs. A spread is the difference between the price you pay to buy a security and the price at which you can sell it. The larger the spread, the larger the cost. Most mutual funds have just one NAV price, for both subscriptions and redemption, and therefore no ‘spread’ to consider.
Which vehicle is for you – Unit Trust or ETF?
As previously pointed out in the article, there is no absolute answer as to which investment vehicle is more superior. A unit trust can perform better than an ETF and vice versa. The performance of either vehicle also depends on the skills of the Fund Manager, the underlying asset class, and the conditions of the invested markets.
The best determiner for which vehicle is yourself – your liquidity needs, preferences, risk appetite and existing portfolio. All of these factors need to be taken into consideration. Therefore, depending on the existing qualities of all these factors at the time of consideration, the vehicle for you could be unit trust, it could be ETF or even a combination of both.
The rising popularity of ETFs offer investors a seamless and cheap method to trade securities throughout normal trading hours. Whether an ETF is for you or not depends on the kind of investor you are.
Do you value the absolute lowest expense ratio and the flexibility of trading intraday? Then ETFs may be for you. If you prefer having exposure and access to mandates not afforded by ETFs, then Unit Trust is better for you.
Associate Director, FX Algorithmic Trading
Raphael has a diverse range of skill-sets from managing infrastructure systems to auditing investment algorithms. Since 2013, Raphael has been researching and developing scalable FX Algorithmic Trading strategies that matched global FX liquidity pools.
Leveraging on his Technology and Finance background, Raphael seeks to present a robust set of algorithm trading offerings for Salzworth Global Currency Fund and to provide relevant connections to benefit clients and partners of Salzworth.