Diversification: Like mutual funds, ETFs offer investors an easy way to diversify. Just as investors purchase shares of a stock in a secondary market, like a stock exchange, they can purchase shares of an ETF, which allows them to access diversified pools of securities.
Transparency: Different types of ETFs offer varying degrees of transparency, but most ETFs disclose information about holdings more frequently than mutual funds, which appeals to investors who want to know exactly what they’re holding. Passive and active transparent ETFs disclose their actual holdings daily while other types of active ETFs typically reveal holdings on a quarterly or monthly basis. Some may also release a mix of actual and proxy holdings on a daily basis.
Liquidity: ETFs trade like a stock in that they can be bought and sold anytime during the trading day, which can be helpful for investors who want more control over the timing of their investments. However, because ETF shares trade intraday, investors may transact at a price that is a premium or discount to actual net asset value (NAV) of the ETF. Mutual fund trades are priced at the end of a trading day, where transactions always occur at the NAV of the fund.
Tax efficiency: ETFs are often known for being tax-efficient vehicles, largely because the ETF issuer is able to reduce the potential for realizing capital gains when raising cash. This is made possible by a unique mechanism known as the creation / redemption process. When a large redemption occurs, the ETF issuer can use in-kind trades (trading securities that the ETF holds in exchange for shares that are being redeemed). The authorized participant (AP) delivers the securities back to the secondary market, which avoids selling fund holdings and helps limit capital gain distributions. Of course, ETF investors will pay tax on any capital gains realized when they sell their ETF shares. Because of this, ETFs may be a good choice for investors with taxable accounts who want to have more control over their annual tax liability.
Streamlined fee structures: ETF fee structures tend to be more streamlined and primarily collect fees that go to the investment manager for the investment and business services the manager provides (and don’t include additional fees for external distribution partners).
Asset managers offer multiple investment vehicles due to client choice and preferences. Below is a chart comparing mutual funds, separately managed accounts (SMAs) and ETFs that can help financial professionals determine which vehicle best fits investors’ needs.
MUTUAL FUNDS
SEPARATELY MANAGED ACCOUNTS
EXCHANGE-TRADED FUNDS
Ownership of securities
Owned by the fund, which invests using money pooled by a group of investors.
Owned directly by the investor.
How to buy or sell
Purchased/sold directly by the fund or through a financial intermediary, such as a broker-dealer. Investors may pay a sales charge or an asset-based fee, depending on the service relationship with the intermediary. Investors may also purchase on brokerage platforms after paying a ticket charge.
Purchased/sold through SMA platform. Typically, investors pay the program sponsor an all-in or “wrap” fee, which includes an investment management fee, a sponsor fee, a brokerage commission for trades executed by the sponsor and other administrative fees.
Purchased/sold like a stock, on an exchange through a brokerage account. Investors may pay a brokerage commission or an asset-based fee, depending on the servicing arrangement with the intermediary. Investors may also purchase on brokerage platforms after paying a ticket charge.
Pricing
Net asset value (NAV) price at the end of the trading day.
Market price based on the individual stocks and bonds held in the account.
Market price on a national exchange based on the bid/ask spread (the difference between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept) around the intraday NAV of the ETF.
Minimum investment
Varies by investment manager and share class but typically range from $250 – $1M.
Varies by strategy but typically $100,000 for equity and $250,000 for fixed income strategies.
Generally, the price of a single share of an ETF.
Taxes
Annual distribution of capital gain. Investors may be taxed on capital gains realized on the sale of their fund shares.
Highest flexibility to manage taxable gains and losses.
Minimal to no capital gain distributions. Investors may be taxed on capital gains realized on the sale of their fund shares.
Intraday liquidity
While investors may transact throughout the day, the share price of transactions uses the NAV calculated as of the end of the trading day.
The underlying security transactions can take place anytime during the trading day and sometimes in extended trading hours.
Transactions can take place anytime during the trading day and sometimes in extended trading hours.
Ability to customize
Yes, as agreed to by the investment advisor
Key benefits
* As with all investment vehicles, ETF investors pay taxes on any capital gains realized when they sell their ETF shares.