Mutual Funds vs. ETFs, and types of ETFs available

With the number of investment options available in the market, choosing the right financial product can be tricky. Mutual funds and Exchange-traded funds (ETFs) are two of the most attractive investment instruments for investors who do not want direct exposure to equity or debt. Mutual funds and ETFs have a lot of things in common. Both are professionally managed and invest in a variety of assets like equity and debt. However, there are few fundamental differences between the two.

Flexibility of investment

ETFs offer flexibility of investment. ETFs are actively traded throughout the day and an investor can buy as low as a single unit at the prevailing cost per unit. Even though the minimum investment allowed in mutual funds is generally low, it does not offer flexibility of investments like ETFs. An investor may not be able to buy just a single unit in a mutual fund scheme as the minimum investment amount in a mutual fund scheme is decided by the asset management company.

Price discovery

ETFs are traded actively on the Stock Exchange, and the price of an ETF unit changes in real-time. Investors can track the performance of an ETF during the trading hours and act accordingly. Since ETFs trade actively throughout the day investors can place different types of orders like limit and stop orders as is usually done for listed securities that provide better control over the investment. On the contrary, the price of mutual fund units does not change in real-time. The price of mutual fund units is calculated after trading hours get over.

Systematic transactions

Mutual funds provide the option to invest and withdraw systematically at specific intervals. It is suitable for investors who want to repeat specific transactions to achieve their financial goals. Option to invest through systematic investment plans (SIP) in ETFs would depend upon the trading platform being used; most of the leading platforms provide the SIP facility in listed securities, including ETFs. If you opt for systematic investment, a predetermined amount will be invested in the ETF fund at specific intervals.

Lock-in period

Unlike mutual funds, ETFs do not have a minimum lock-in or holding period. Investors are free to sell their investments whenever they want. Some categories of mutual funds may have a lock in feature, like ELSS funds that have a 3 year lock in or some funds that are launched as close ended funds for specific time periods during which time they cannot be exited. Open ended funds can be exited anytime but may have exit loads that can range from a few days to year typically.

Commissions

Considering ETFs are traded like shares, investors must pay trading expenses including brokerage while selling or purchasing units. Investors would be subject to a total expense ratio charged by the fund house, which includes management fees and operational expenses. When it comes to mutual funds, unless they are traded on the exchange, there may not be any trading expenses borne by the investor; however, like with ETFs, mutual funds investments would also be subject to the total expense ratio charged by the fund house. Typically, one can expect the expense ratio of ETFs to be lower than the expense ratio of mutual funds.

Management

Most mutual funds are actively managed by professional money managers who take all the decisions on behalf of the investors. Most ETFs, on the other hand, solely track the market indices and hence do not require active management. However, there are certain ETFs that are actively managed.

One can choose to invest in an ETF or a mutual fund scheme depending on his/her financial objectives. There are various types of ETFs available in the market. Investors can choose an ETF that can be used to generate income, , or to hedge, or offset risk in their portfolios. Some of the most popular ETFs are:

•       Equity ETFs
•       Bond ETFs
•       Industry / Sector ETFs
•       Thematic ETFs
•       Commodity ETFs

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