What Are ETFs & Unit Trusts?

In addition to the explanation of ETFs & unit trusts in the section “An Introduction To Various Investment Products”, in this section, we provide further explanation on what these investment products are.

iFAST Research Team
iFAST Research Team06 Dec 2016Views
What Are ETFs & Unit Trusts?
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ETFs and unit trusts are simply portfolios comprised of several of individual investment products (such as stocks, bonds, money market instruments, and alternative assets, to name a few) and hence they are also termed ‘Collective Investment Schemes (CIS)’. As a recap from an earlier section on ETFs & Unit Trusts, we have summarised the similarities and differences between both products in the table below.

 

 

ETF

Unit Trust

Structure

  • Mainly open-ended

 

  • Listed
  • Passively managed,  tracks and replicates the return on an index
  • Cash-based (invests in component securities of an index) or Synthetic (invests in derivatives with the aim to produce returns on an index)
  • Unlisted
  • Actively managed, aims to outperform a related index
  • More varied, each with their own investment objectives and strategies

Broad Categories

  • Equity
  • Bond
  • Commodities
  • Equity
  • Bond
  • Balanced
  • Money Market
  • Short Duration
  • Alternative Investments

*Risks

  • Market risk
  • Foreign currency risk (not all funds)
  • Risks pertaining to the political, economic, and social factors of a foreign country (not all funds)
  • Interest rate risk (not all funds)
  • Counterparty Risk (synthetic ETFs and some unit trusts)
  • Tracking error

 

Challenges in replicating the underlying index exactly include requiring large buy and sell orders which may not be easily fulfilled and the transaction costs incurred when buying and selling underlying securities which would reduce the overall returns of the ETF.

  • No Tracking error

Pricing per Unit

  • Depends on market demand and supply of fund units.

 

ETF unit prices are quoted with bid and ask spreads, similar to regular stocks on the stock exchange. Hence, ETF unit prices may vary according to market demand for the units and may differ from the market value of the underlying assets.

  • Net Asset Value (NAV)

 

Unit trusts are quoted based on NAV, thus prices often closely reflect the market value of the underlying assets.

Benefits

  • Lower costs as their annual management fee is significantly lower given that they are passively managed, in contrast to unit trusts
  • Intraday pricing
  • Risks generally do not significantly exceed that of the underlying index
  • Investors have greater certainty over component securities given that ETFs typically replicate indices. This is unlike unit trusts, where the decision to include or exclude certain securities from the portfolio is usually at the discretion of the fund manager.
  • Utilise professional expertise
  • Higher flexibility in selection of portfolio securities
  • Potentially higher returns beyond that of related indices
  • Unit price typically reflects the market value of underlying securities given that it is derived from the NAV of the fund.

Drawbacks

  • Returns typically do not exceed that of the underlying index
  • Unit price may not reflect the market value of underlying securities. Should there be strong demand for the ETF units, unit price may be higher than the NAV of the fund.
  • Higher costs
  • Possibility of risks exceeding related indices

 


 *Risks listed are the common risks only and thus are not exhaustive.

Which investment product, ETF or unit trust, is more suitable for me?

As previously pointed out in the previous section on ETFs & Unit Trusts, when it comes to performance, there is no definitive answer as to which investment product is better. Sometimes, unit trusts outperform ETFs, whereas in some other cases, ETFs outperform unit trusts as markets are dynamic and unpredictable, thus not all the time fund managers manage to outperform the related indices! Conclusively, the suitability of either product to an investor depends on his unique needs and preferences which dictate his risk-return profile, and perhaps a combination of both would bring the best of both worlds!

 

 

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