What do investors seem to neglect today: Exchange Traded Funds (ETF) Vs Traditional Mutual Funds (M/F)

authored by
Dimitris Kostaras
01.12.2020
New to Investing
8 minutes read

It is true that the most diversified portfolios today are comprised of Exchanged Traded Funds (ETFs) in advanced markets, but not in Greece. And the question is why?

In this article we will try to analyze some of their key differences with Mutual Funds (mutual funds) and examine the reasons behind this.

DEFINITION

ETFs are Mutual Funds that trade in a regulated market. Specifically, an ETF is a capital invested in equities or bonds or other securities and trade approximately at the same price as the underlying assets of the portfolio. Furthermore, they trade during the whole session and not only at its closing like M/Fs do.

Most ETFs are passively managed. They track a benchmark index and the returns are close to the ones of the index.

SIMILARITIES WITH M/Fs
• Are less risky than investing directly in stocks and bonds
• The provide a huge variety of investment choices
• Are managed by professional managers
• ETFs established in ΕΕ are treated for tax purposes such as M/Fs in Greece.

DIFFERENCES
• Low investment minimums
• Significantly lower costs
• Great control over the price as they are executed at real prices compared to M/Fs that are executed at each day’s closing.
• No delay in transactions compared to M/Fs
• Ideal for tracking stock market indices
• Transparency in their asset possession with daily reports vs monthly reports of M/Fs

TODAY’S SITUATION

ETFs is a rapidly developing market reaching worldwide $ 7 trillions (Source: Investopedia) since their advantages fully meet current era where there is a true digital evolution and zero or negative interest rates put a lot on pressure on issues that have to do with products’ costs.

Until the middle of the last decade, even a money market fund in euros could achieve an annual return of 1,50-2,00%, so an average annual expense of 2,00-2,50% could be reasonably charged to the investor.

In the current period with 1/3 of bonds in euro being at negative levels, the money market funds also negative and the prediction that interest rates will remain negative for many years, commissions that are stuck to another era’s levels cannot be sustainable anymore.

Also, long- term studies have shown that about 80% of mutual funds fall short of the benchmark in a period of more than 10 years. This specific percentage even jumps to 91,6% when the holding period of the investment exceeds 15 years, something that is very common in savings accounts. (Source: CNBC)

Nevertheless, 35% of M/F do not survive a decade, where usually the solution is to merge with another M/F of the same manager.

GREEK REALITY AND M/F CHARGES

So, since ETFs have become a very important investment tool worldwide, why do not banking networks in Greece suggest investing in ETFs?
The answer is very simple and focuses on one word: Revenues

Traditional investment networks base their profitability on the mutual fund commissions system.

• Entry fee 0.5% -3%
• Kickbacks from the annual expenses that a mutual fund charges internally (management fees). If you want an outlook on the total charges (total expense ratio/TER) look for the factsheets or the key information document (KIID) of your mutual fund.

In general it ranges between: 1,30%-2,20% for bond M/F & 1,50%- 3,00% for stock and mixed M/F

Theoretically, according to Μifid II directive, the commission refund process is legal, but your bank is obliged to inform you both initially in a comprehensive manner and have your written consent and annually in detail about its revenues from the M/Fs you have and about other expenses that you have been charged by third parties (custodian etc), which you might ignore until now.
• Exit fee affiliated with the holding period if there has been a discount on the entry fee or it has been zero

Also since the era of capital controls in foreign capital, banking networks promoted then as a necessity and then as an option, M/Fs of their own networks, as in this case all management fees of MF/s along with the commissions remain in the banking network.

ETF CHARGES

The big majority of ETFs (over 80%) are passive, meaning that they track stock market indices, and their annual costs (Total expense Ratio/TER ) range between 0.03% and 0.50% and there is a charge for each transaction as a stock market product. In our investment plans at XSpot Wealth, the costs of the ETFs we use do not exceed 0,15% of the annual charges and have no entry/ exit fees at all.

REBALANCING M/F

Rebalancing with the use of M/Fs is an agonizing process for the client in terms of costs since the client is charged with entry fees, possibly also exit fees and has to wait up to one week for the process to complete.

For instance a client that gives an order at 12.30pm to sale a M/F, it will close the next day, which means that if he invests in US stocks, he will have to sustain 2 passive future index closings and a Τ+3 or Τ+4 liquidation, that is still applicable for some fund managers, resulting in his waiting up to 1 week to take his money so as to carry out the rebalancing.

With S&P 500 having in 2020 a daily fluctuation of 1% in over 85 sessions already, an investor could easily lose 2-3% of the expected return at the time of liquidation and be charged respectively a 2-3% entry fee to a new M/F, a cost that could sum up an expected annual return.

REBALANCING ETF

The portfolio rebalancing process can practically happen immediately after the sale, which can be executed at a predetermined price and respectively then takes place the purchase, just a few minutes later and in determined prices, compared to the price uncertainty of M/Fs and the time lag between sale and purchase. In our case the only charge that someone incurs in rebalancing is the transaction and clearing cost at 0,10% of the value, which means that for a portfolio rebalancing of 10,000 euros, the cost only amounts to 10 euros, while with the M/Fs this cost can range between 1,50-3,00% or 150-300 euros.

WHY ETFs?

We mentioned earlier that 80% of M/Fs are lagging behind the benchmark they track. Even some of those that beat the indices, are forced to take extra risk to achieve returns due to high costs, resulting in higher volatility especially in periods of fluctuations such as this year.
Let’s take an ETF that passively tracks an index, for example S&P 500. Assuming that in a year the index has a 10% return, the ETF will have a return of 10% minus the costs, that should not exceed 0,10% for the specific index.

WEALTH MANAGEMENT THROUGH ETFs

In XSpot Wealth we use low cost investment tools, such as ETFs from world- class providers, to build fully diversified portfolios. We strongly believe that passive investments that are actively managed, in terms of risk, turn out to be more effective in the long term than an active investment strategy, where fund managers choose stocks or bonds they believe will perform best.

This article does not constitute and shall not be construed as a prospectus, advertisement, public offering, or placement of, nor a recommendation to buy, sell, hold or solicit, any investment, security, other financial instrument or other product or service. This document is for general information only and is not intended as investment advice or any other specific recommendation as to any particular course of action or inaction.