ETF and Stocks: A Comparative Analysis

The fascinating world of investing is full of investment products to achieve financial goals, commitments or long-term capital appreciation. While the markets offer a lot of investment products to choose from, the investors should be sophisticated enough to choose among the products that suit the circumstance of the investors. For instance – a 24-year-old person may invest in volatile markets to achieve desired returns; however, investing in the volatile markets doesn’t seem right for a person approaching retirement.

Investing should not be considered as just allocating money to some financial instruments. Investors must understand their situations, as well as the conditions of the markets. The timing of the investment is a very crucial part, which includes opening a position in any investment and closing of the same position. For instance – the returns of the investment vary from period to period and acquiring investments at cheaper prices would be a better timing to gauge the investment returns later at a stage when the investments are highly priced in the market.

A dive into the world of ETFs

Exchange Traded Fund (ETF) is a type of investment product offered in the market, which trade like securities on the exchange. Further, ETFs may contain investments that include bonds, derivatives, equities, commodities etc. It is a professionally managed investment product by the investment management firms and is also regulated by the market regulator.

In Australia, ETFs are a part of investment products considered as Exchange Traded Products (ETPs) by ASIC. ETPs include ETFs, managed funds, structured products, and ASIC keeps a close eye on these products to safeguard the interests of investors. According to ASIC, the market regulator intends to maintain the sovereignty of the market. In this regard, it expects the licensed exchanges to ensure a robust and transparent pricing mechanism, which allow investors to transact ETP units at a price closely resembling the Net Asset Value (NAV). Further, ASIC expects exchanges to ensure appropriate naming conventions for the funds, which should differentiate between the kinds of risks associated with the funds. Below are some guidelines from ASIC on the naming conventions:

ETF – ASIC asserts that ETF can be used only when the fund pursues a passive investment strategy to replicate the performance of widely available benchmark, whose values are continuously disclosed and immediately available.

Active ETF – The word ‘Active ETF’ should be adopted by a fund where the investment strategy pursued by the fund is active investing. These funds cannot be just called ‘ETF’, and the term ‘Active ETF’ should be used while naming the funds along with ‘managed fund’. For instance – ABS Active ETF Managed Fund.

Hedge Funds – Hedge Funds are considered ETPs when the criteria are met by the fund, which is disclosed by ASIC under Regulatory Guide 240 (RG 240). The funds meeting these criteria must use the words ‘hedge fund’ in the name. Under RG 240, ETPs which are regarded as the fund of hedge fund must use the word ‘hedge fund’ or ‘fund of hedge fund’. It should be noted that these funds cannot be named as ‘managed fund’ or ‘synthetic fund’.

Managed Fund (quoted) – ASIC directs that the collective investment vehicles that are not able to use the word ‘ETF’ or ‘Hedge Fund’ should use the words ‘managed fund’ in the name of funds.

Synthetic – The word ‘Synthetic’ can be used when the investment strategy of the fund enumerates the use of derivatives. If the aggregate allocation in the derivatives is above 10% of the NAV; the word ‘Synthetic’ must be used. Meanwhile, derivatives held to hedge the forex risk are not considered in the 10% limit.

Structured Product – Any security or derivative providing exposure to the performance of underlying asset should use the word ‘structured products’ in the name. Further, it cannot use the word ‘ETF’, ‘active ETF’, ‘managed fund’ or ‘hedge fund’. For Example – A combination of bonds and derivatives in a fund to provide desired returns.

Stocks: Contradiction to ETFs

Stocks are a type of equity investments representing the ownership of the company, and this entitles the holder of the stock to the company’s earnings and assets. Once the stocks are issued in Primary Markets, investors can sell those shares or buy those in the secondary market.

In Australia, there are mainly four types of common equity which include ordinary shares, stapled securities, CHESS Depository Interest (CDI) and Exempt. ASIC continuously monitors the activity in the equity markets to promote fair and reliable market conditions. Let’s look at the scenario for equity investments in Australia:

Ordinary Shares – These are the type of securities listed on the stock exchange, and these shares are entitled to vote on the decisions by the company. At times, activist investors leverage the power of ordinary shares to influence the decisions made by the companies. Shares are the portion of the ownership in the company; thus, the number of shares held by investor represents a certain percentage of ownership or interest. Importantly, following the liquidation of the company, these shares are the creditors and the preferred shareholders are ranked higher, when the debt is paid.

Stapled Securities – These securities are formed through a combination of units from a trust and shares in the company. Mostly, this applies to integrated property group wherein the trust holds the property, and a separate entity manages the fund. In this regard, the property group can use stapled securities to form a collective investment instrument.

Ordinary Foreign Exempt – The securities with dual-listing on ASX and NZX are considered in this category; however, it should be noted that companies which fall under the jurisdiction of New Zealand are eligible for the foreign exempt category.

CHESS Depository Interest – CDIs are the shares of international companies traded on ASX. It allows investors to participate in the growth of international companies listed on ASX.

ETFs Vs Stocks

Differences between stocks and ETFs are based on the below characteristics:

Professionally Managed – ETFs are professionally managed investments while the infinite upside potential is not foreseeable in any investment. It can be said that the asset/investment managers have professional knowledge, and the returns depend upon the strategy and the economic aspects of business wherein the strategy directs to invest. So, investors must choose the strategy to achieve certain goals and invest accordingly. An individual investor allocating capital to equities could be beneficial; however, it may carry the risk of inadequate knowledge, resources and may be capital.

Dividends – ETFs and Stocks distribute income while the dividend income from the stock cannot be guaranteed due to the stage of business of the company, earning during the period etc. However, ETFs distribute income regularly based on the earnings by the fund from the stock it holds.

Diversification – ETFs offer diversification in the portfolios of investors, as it holds numerous securities the gains and losses made by each security are offset, resulting in a collective positive or negative return. Using diversification in stocks is possible; however, it would require place multiple orders to buy multiple securities paying multiple brokerages etc. Meanwhile, ETF provides diversification at one single investment.

Focused Investment – If an investor is extremely influenced by a business of any company and expects it to outperform in the market. In such a scenario, investors should allocate some of the investments to such companies to avoid getting exposed to various securities held by an ETF.

Disclaimer

This website is a service of Kalkine Media Pty. Ltd. A.C.N. 629 651 672. The website has been prepared for informational purposes only and is not intended to be used as a complete source of information on any particular company. Kalkine Media does not in any way endorse or recommend individuals, products or services that may be discussed on this site. Our publications are NOT a solicitation or recommendation to buy, sell or hold. We are neither licensed nor qualified to provide investment advice.