There are a lot of pooled funds to choose from. The most popular ones among individual or retail investors are exchange-traded funds or ETFs, mutual funds or MFs, and unit investment trusts or UITs. Some might think that they are all the same. This is understandable because they are all based on the same concept of combining funds from different investors to build a large pool of capital for investing in different securities or asset classes. However, because of their unique characteristics, in addition to their respective advantages and disadvantages, choosing which among the three to invest in involves understanding the differences between them.
What are the Differences Between these Three Retail-Focused Pooled Funds: Explaining Exchange-Traded Funds vs Mutual Funds vs Unit Investment Trusts
1. Creation and Structure
One of the notable differences between exchange-traded funds, mutual funds, and unit investment trusts centers on how each of them is created and structured. Remember that all three are pooled funds. Both ETFs and MFs are created and issued by investment companies and brokerage firms. Some companies that offer MFs are also called mutual fund companies. A particular UIT represents both a pooled investment fund and is either a regulated investment corporation or a grantor trust under the Investment Act of 1950 of the United States. However, in other countries, UITs are specific investment products offered by investment companies and banks.
2. Investment Strategy
Both ETFs and MFs can either be actively managed or passively managed. It is important to note that passive management is more popular in ETFs because their investment objective is to mirror benchmarks or indices. Active management is more popular in MFs because their objective centers on outperforming benchmarks. All UITs are passively managed. This is one of their defining characteristics. An actively managed portfolio of securities and assets is dynamic because it involves constant reconfiguration and rebalancing. A passively managed portfolio is also called a fixed portfolio because the underlying securities and assets are static.
3. Access and Ownership
ETFs differ from MFs and UITs because they can be bought and sold or traded in stock exchanges like stocks. An ownership of a particular ETF is represented as a share. MFs are not traded on exchanges and are bought or redeemed directly from the fund company at the net asset value. Both ownership and investment in a particular type of mutual fund are also represented as shares. UITs are similar to MFs because they are also not traded in exchanges. The process of investing in a specific UIT involves purchasing units. These units represent a portion of ownership and investment in the underlying securities and assets of a particular UIT.
4. Liquidity and Duration
All three retail-focused pooled funds are considerably liquid. ETFs can be sold to an exchange. MFs can be redeemed through partial or full redemption of owned shares. UITs are also partially or fully redeemable through unit cancellation. Both ETFs and MFs are also open-ended funds in general. This means that there is no limit on the number of shares that can be issued and redeemed. Investors can also hold on to their investments for as long as the funds exist. These funds do not have a lifespan in general. The units of a particular UIT are predetermined on its creation and no additional units are created. A UIT also has a set lifespan or maturity date.
5. Flexibility From Selection
One of the advantages of investing in pooled funds is that they provide investors with an easier and more affordable route to investment diversification. An investment in a particular pooled fund means an investment in a basket of securities and assets. All three retail-focused pooled funds share these advantages. However, when it comes to flexibility, ETFs are more flexible because they are more accessible and are tradable. Both ETFs and MFs still have a considerable selection of funds to choose from. Each fund is aligned to a particular risk profile. UITs tend to have a limited selection of funds and their fixed portfolio makes them less flexible.
6. Associated Costs and Fees
The variations in associated costs and fees represent another difference between exchange-traded funds, mutual funds, and unit investment trusts. All three are still considered more accessible investment options than purchasing individual securities and assets. ETFs and UITs are considered to have lower expense ratios than MFs. MFs are considered to have higher expense ratios most of the time. Both ETFs and MFs that are actively managed are costlier than passively managed ETFs and MFs. UITs have lower expense ratios because they are passively managed. Both MFs and UITs may incur upfront sales charges or commission fees and redemption fees.
Summary of the Differences Between These Three Retail-Focused Pooled Funds: Exchange-Traded Funds vs Mutual Funds vs Unit Investment Trusts in a Nutshell
The differences between exchange-traded funds, mutual funds, and unit investment trusts are not as straightforward but are still discernible. ETFs and MFs share the same similarities of being more flexible because of their wider selection of funds and open-ended orientation. Both also have funds that are either based on active management or passive management. UITs are less flexible because of their limited fund selection, set maturity date, and fixed portfolios.
ETFs still provide lower potential costs, a wider range of investment options, and superior liquidity. These make them ideal for either a buy-and-hold investment strategy or regular trading activities. MFs also offer a wide range of investment options from fund selection. The minimum investment requirement is also lower than ETFs. This makes them ideal for a buy-and-hold investment strategy. UITs are also suitable for long-term investments that can last from 15 years to 20 years. They are also less liquid compared to both ETFs and MFs.