ETF v Funds

boxwood

Index trackers e.g. Vanguard, L&G, Blackrock iShares, HSBC. Do they actually hold shares in the constituent companies in the index, in proportion to the number of investors they have holding units in the fund or ETF? If you want the security of knowing a fund or ETF holds assets of equal value to all investors holding based on the current market price, do Vanguard, L&G, Blackrock iShares, HSBC index trackers? Are Funds 'safer' than ETFs, what to look for, and what to avoid? If there is a Fund and ETF tracking the same index, tracking error, costs, performance all comparable, would you choose the ETF or Fund?

grey_gym_sock

i think all index tracker funds actually hold the shares in the index, and so do physically replicated ETFs, but there also synthetic ETFs which don't (and which i would always avoid using). if an ETF's description mentions "indirect replication" or "swaps", then that probably means it's synthetic.

when i say they hold the shares in the index, that doesn't always mean all the shares in the index; sometimes, it means a (hopefully) representative selection of the shares. the latter might be described a "partial replication". IMHO, partial replication is probably fine if the index contains 1000s of shares; but if it only contains 100 or so, i'd want complete replication.

funds or ETFs based outside the UK (which in practice seems to include all ETFs) don't have FSCS protection. and they may or may not instead have protection from equivalent schemes in the country they are based in. however, FSCS protection for a fund is not something one would expect to have to call on, and i would not be too concerned about this.

on some platforms, it can be cheaper to hold ETFs rather than funds, especially if you have a large amount invested (tens of thousands of £) and rarely buy or sell.

with ETFs, you should ideally be looking out for whether the price when you buy or sell is reasonably close to the NAV. funds are automatically bought or sold at the appropriate price. so funds are a bit simpler to deal with.

when not using a tax shelter (i.e. not in an ISA or SIPP), tax is a bit more complicated for funds or ETFs based outside the UK. because there can be "excess reportable income" to consider.

boxwood

Thanks for that. Funds and physically replicated ETFs hold shares in the actual equities in the index they are replicating. But for each company for which they hold shares, do they hold a number of shares equal to the number of clients holding units in the fund or ETF? So if there are 1,000 investors each holding 10 units of 'Global Tracker index of 3,000 companies' will the fund or ETF actually hold 10,000 shares of each 3,000 companies, so that every investor's holding is backed by a number of physical shares equal to the number of units they hold?

grey_gym_sock

no, the number of shares they hold is not equal to the number of clients. the number of shares is based on how much money they have to invest, and how large a part each company has in the index.

e.g. if it's a world index, apple might be c. 2% of the index, so they use 2% of the cash they're investing to buy apple shares - regardless of the number of apple shares that gives them. and then perhaps 1.5% of the cash is used to buy google shares. and so on for other companies (so less cash goes into smaller companies).

if you work out the number of shares which could be said to indirectly belong to each client, that would be proportionate to the number of units each investor holds in the fund (or the number of shares they hold in the ETF), so it would be different for each investor. and for smaller investors, it would come to a fraction of 1 share in each company.

dunstonh

Are Funds 'safer' than ETFs, what to look for, and what to avoid?

Generally yes. However not due to the assets but the fact funds have FSCS protection. ETFs do not. And ETFs have a few more things to look out for (synthetic vs physical as mentioned already). So, its more a knowledge and understanding risk increase.

would you choose the ETF or Fund?

I typically pick UT/OEICs because a) FSCS protection b) knowledge and understanding of the consumer c) dealing costs and d) annual cost differences are not what they used to be.

For example, HSBC 250 index has performed virtually the same as Vanguard 250 ETF. Both They are within 0.25% after nearly 4 years and they both have days when the one is slightly (fractional) better than the other. HSBC has no dealing costs. Vanguard does.

Dealing costs are an issue to consider. If you are going to be building a portfolio of funds, when you want to rebalance each year, funds allow you to rebalance without concerns of dealing costs (bar being aware of soft closures and the small number that still have spreads). If you had dealing costs, you have to consider the sale cost and buy cost of each ETF when rebalancing.

Dealing costs may not be as much as an issue if you invest in a platform that focuses on direct assets rather than funds. Whereas a platform that focuses on funds may not be as cost-effective for direct assets.

masonic

dunstonh wrote: »

Generally yes. However not due to the assets but the fact funds have FSCS protection. ETFs do not. And ETFs have a few more things to look out for (synthetic vs physical as mentioned already). So, its more a knowledge and understanding risk increase.

I was under the impression that ETFs had FSCS protection, either directly for those domiciled in the UK, or indirectly through the EU passporting scheme for those domiciled in Ireland and elsewhere in Europe.

Edit: Monevator seems to confirm this view.

dunstonh

https://www.moneyadviceservice.org.uk/en/articles/tracker-funds-index-funds-exchange-traded-funds

The FSCS applies to financial advice and investment firms, not shares.

ETFs bought directly are therefore not covered by the FSCS.

So, if I recommend an ETF as part of a portfolio and my advice was bad then there is FSCS protection. If the ETF fails, there is no FSCS protection.

Monevator seems to be relying on a Vanguard document that is referring to investment funds rather than ETFs.

masonic

Yes, it seems there is some discussion around this in the comments and confirmation from some of the major providers that their ETFs are not covered.

I suppose there is still the same protection in place against fraud by the investment firm with which you have a trading account, but lack of protection against fraud by the company managing the ETF is a drawback.

So this raises the question, are Investment Trusts shares or investment firms for the purposes of the FSCS?
Edit: To answer my own question, they are not covered either (that's what I had presumed)

boxwood

Thank you, very useful information and good to know!

Tom99

dunstonh wrote: »

Dealing costs are an issue to consider. If you are going to be building a portfolio of funds, when you want to rebalance each year, funds allow you to rebalance without concerns of dealing costs (bar being aware of soft closures and the small number that still have spreads). If you had dealing costs, you have to consider the sale cost and buy cost of each ETF when rebalancing.

[FONT=Tahoma, sans-serif]Whether you pay a dealing fee to buy/sell Funds will depend which platform you are using.[/FONT]
[FONT=Tahoma, sans-serif]I am with Halifax who charge £12.50 per trade for Funds but you can use the regular investment option to buy for £2 but not to sell, which is always £12.50.[/FONT]

horace972897

Don't forget there is no stamp duty on ETF's so for larger purchases this can balance the dealing costs easily (e.g. Buying £2000 worth of an ETF would save 0.5% Stamp duty = £10)


Regarding FSCS protection - my understanding is that you won't get FSCS protection for non UK domiciled ETF's (as that's a UK protection) but you may get protection from the regulator in the county your ETF is domiciled in - e.g. In Ireland if the company is authorised by the Irish regulator you get some protection (Euro 30000 if i recall correctly)


Additionally for me I like knowing how much i'm paying for, or getting, at the time of sale/purchase, unlike with funds where you're waiting to find out the numbers.