Education / ETF Basics

ETF vs. Mutual Fund, a simple and complete comparison

ETF enjoys the advantage over Mutual Fund over real-time price, the capability of intra-day trading, low cost, greater transparency, and no minimum investment requirement.

These differences largely result the subdued performance of mutual fund compared to its ETF equivalent.

Oct 2019 ~ 4 mins read

The base line

ETF and index tracking mutual fund do the same things. Both seek to track an underlying index and achieve returns that closely correlate to the returns of that index, with low fees.

However, there is a small but growing number of actively managed ETFs and a large number of non-index tracking mutual fund, for which the portfolio managers do not adhere to passive index tracking strategy, but rather make active investment decisions, aiming to outperform the benchmark index. It remains of the most divisive issues in investment management of whether active investment management delivers superior returns by charging a high fee, or whether it is evident that no one can “beat the market” over a period of time. Hence force, passive investing is an easy and cost effective way to achieve compatible returns.

The similarities

For instance, two investment products — ETF and Mutual Fund that are designed to track FTSE 100, one is iShares Core FTSE 100 UCITS ETF, and the other is iShares 100 UK Equity Index Fund (UK). Both hold about 100 equity stocks in approximately the same weight as in FTSE 100 index. Both have dividend accumulated and reinvested into the funds, and both have the same base currency in GBP. Performance wise, these two funds are very closely correlated. The two investment products are very similar at this point.

Chart 1. ETF and Mutual Fund Performance Comparison

The differences

By rebasing the ETF and Mutual Fund’s price at 100, assuming 100 GBP is invested in both funds at the end of October 2017, investors gain almost 110 GBP in FTSE 100 UCITS ETF, compared to only 105 GBP in the mutual fund equivalent. One of the reasons of subdued performance in mutual fund is due to its high cost. A few basis points cost difference may not seem a big deal. Because investment cost compounds, over a time, funds with high cost tends to suffer. See our Search Hub on — What the ETF cost consists of, and how it impacts the performance?

Chart 2. ETF and Mutual Fund Fee Comparisons

The difference is that ETFs are “Exchange Traded”. Like equities, ETFs are listed on a stock exchange (or multiple stock exchanges in Europe), and you can buy and sell them intraday at the time when the stock exchange is open. Whereas for mutual fund, you can put a buy or sell order anytime during the day, but the order will be fulfilled or traded only once a day, after the close of trading, at a price you don’t know until the close.

To sum up, ETF enjoys the advantage of

  • Real-time price
  • Intra-day trading
  • Low cost
  • Greater transparency
  • No minimum investment requirement

That these dragon means to the investor? Let’s try to understand from the detailed factual level.

The variety of ETFs with exposure to different countries/regions and sectors bring investors the flexibility of using ETF to achieve different goals. There are many different ways that investors use ETF.

  • Long term core strategy to track broad market performance (e.g. S&P 500 or MSCI World) with monthly contribution.

  • Satellite investment such as smart beta investment to tilt towards pre-determined financial matrices, e.g. High Dividend payment, Low Valuation, Strong Momentum, Low Volatility, etc., aiming to outperform traditional benchmarks. See Smart Beta ETFs

  • To capture niche trends in economic, corporate, social or technological themes. e.g. Cloud Computing, Aging Population, etc. See Thematic ETFs

  • A liquid instrument to invest in illiquid or hard-to-reach market, e.g. China, Russia, or South Africa, etc.

Chart 3. How to Use ETF to Build an Investment Portfolio Simulating Mutual Fund Strategies.