Many people conflate ETFs (exchange-traded funds) with ‘passive’ management and unit trusts or mutual funds (Funds) with ‘active’ management. This is a fallacy. In reality, there are both actively managed ETFs, where portfolio managers select securities in an effort to outperform a benchmark, as well as many passively managed Funds.
A related myth is that all passive products are market-cap weighted and track general stock market indices, meaning investors only get the market’s beta. Today’s passive investment universe is very diverse.
There are ETFs and Funds that passively track commodities like gold and oil, cryptocurrencies such as Bitcoin, thematic baskets around renewable energy or AI, factor styles like value or momentum, and geographic exposures such as emerging markets. Passive investing no longer equates to vanilla exposure to an index like the MSCI World or S&P 500.
Actively managed ETFs are a slightly newer development. These are stock exchange-listed funds managed by professionals who select securities to buy and sell with the aim of outperforming a benchmark. Unlike passive ETFs, which track an objectively defined market index or set of instruments, actively managed ETFs rely on portfolio managers and researchers to make subjective investment decisions.
One of the reasons that passives have become so popular is that they usually offer lower costs compared with most traditional active funds. Their structure allows them to replicate investment styles such as value, momentum, or quality at a fraction of the cost of an actively managed fund.
Traditional active funds usually attract significantly higher management costs. This creates a higher performance floor because the fund must cover these fees before generating a return. The effect is intensified over time because even modest annual management fees can erode returns from long-term compounding.
The active versus passive debate has been raging for decades and is beyond the scope of this article; suffice to say that we are proponents of both and combine them in clients’ portfolios.
Decoding the pros and cons of ETFs versus Mutual Funds and Unit Trusts
So, if an ETF can be both active and passive, and the same with a Fund, then what are the differences between them?
ETFs can be traded instantly: ETFs, whether actively managed or passive, are listed on securities exchanges and are traded throughout the trading day at market prices, in much the same way as any other listed stock or instrument. Investors benefit from real-time pricing and the ability to execute trades nearly instantly. The price of an ETF depends on the exact time your order is placed and executed. This can be advantageous during times of higher volatility, when markets are moving quickly and investors want to capture opportunities or limit downside risk without waiting for end-of-day fund pricing. This is, of course, subject to liquidity and market depth. Being able to trade instantly is not possible if there are no willing buyers or sellers at the time.
ETFs have bid-offer spreads and brokerage fees: ETFs also face a bid-offer spread (the difference between the bidding and asking price), which adds to the total cost of ownership and thus diminishes overall returns. This is less of a concern for the more liquid and popular ETFs than for more thinly traded products. While ETFs may have lower ongoing expense ratios than traditional funds, the fact that brokerage fees need to be paid upon buying and selling also eats into returns, especially for smaller or more frequent trades.
Funds are traded on net asset value: Unit trusts or mutual funds, by contrast, are priced at the end of the trading day and are typically bought or sold based on net-asset value (NAV) calculated after the market closes and without brokerage. No matter what time of the day you place a trade, you’ll get the same price as everyone else who bought and sold that day. The price is calculated based on every security owned by the fund, with no bid-offer spread, regardless of whether a trader is buying or selling. Investors are guaranteed that the transaction value matches the underlying portfolio value at the end of the day, not a market price influenced by supply/demand imbalances.
Funds cannot be traded ‘live’ but guarantee liquidity: This can feel frustrating for investors who would prefer to be certain that the price they are quoted during the trading day is the same one they will get when the transaction is settled. Funds may, therefore, seem less flexible for investors who are looking to time their entry or exit more precisely. A key advantage of Funds, however, is that they offer guaranteed liquidity at NAV. This means investors can always buy or redeem units directly without worrying about market depth or pricing distortions. The trade-off is that Funds need to hold cash to meet redemptions, which creates a cash drag that can weigh on performance. Unlike ETFs, Funds can be purchased in fractional shares. This makes them suitable for investors who want to invest a consistent amount of rand or dollars each month without leaving cash on the sidelines. On the downside, some Funds have minimum investment requirements.
Practical use in our portfolios
Availability of instruments: First and foremost, the Dynasty Investment Committee will evaluate which building blocks to include in constructing clients’ portfolios. While some components will only be available as ETFs, others will be limited to Funds. In particular, instruments that track broader market indices may be available in both ETF and Fund ‘formats’.
In practice, investment platforms also shape usage: Many investment platforms default to listing Funds, while stockbrokers operate primarily on exchanges and therefore favour ETFs. Our preferred investment platform, DMA, provides access to both ETFs and Funds, locally and offshore, offering greater flexibility for client portfolios.
In conclusion, we view ETFs and Funds as complementary instruments and make extensive use of both in most of our client portfolios – either directly or indirectly through our house view funds.
