Understanding the array of available investment vehicles is crucial for building a diversified portfolio that aligns with your financial goals. Funds, investment trusts and ETFs are popular choices among investors, each offering unique features, benefits and considerations, but how do they differ? This article examines the distinctions between these investment options, helping you navigate your investment journey with greater confidence.
FUNDS: POOLED INVESTMENTS MANAGED ACTIVELY OR PASSIVELY
Funds are investment vehicles that pool money from many investors to purchase a diversified portfolio of stocks, bonds or other securities. In the UK, two common structures are unit trusts and open-ended investment companies (Oeics).
These funds are managed by professional fund managers who make decisions about buying and selling assets within the fund's portfolio. Funds can be actively managed, where the goal is to outperform the market, or passively managed, aiming to replicate the performance of a specific index.
One of the key benefits of funds is the ability to gain exposure to a broad range of assets, which can help diversify risk. Investors also benefit from professional management, making funds an attractive option for those who prefer not to manage their investments directly. However, funds typically charge management fees and other expenses, which can impact overall returns. Additionally, funds are priced once a day at the close of the market, meaning investors can only buy or sell shares at the end-of-day net asset value (NAV).
INVESTMENT TRUSTS: CLOSED-END FUNDS WITH A FIXED SHARE STRUCTURE
Investment trusts, also known as closed-end funds, are publicly traded companies that invest in a variety of financial assets. Like funds, they are managed by professional fund managers. However, unlike funds, investment trusts have a fixed number of shares that are traded on stock exchanges, similar to individual stocks. This closed-end structure can lead to shares trading at a premium or discount to the NAV of the trust's assets, depending on market demand.
Investment trusts can borrow money to invest (known as gearing), potentially enhancing returns but also increasing risk. The fixed share structure allows fund managers to take a long-term view without worrying about redemptions, which can be beneficial during volatile market conditions. However, the possibility of shares trading at a discount or premium adds an extra layer of complexity, opportunity and risk for investors.
EXCHANGE-TRADED FUNDS: A HYBRID APPROACH
Exchange-traded funds (ETFs) combine features of both mutual funds and investment trusts. Like mutual funds, ETFs pool investor money to buy a diversified portfolio of assets. However, ETFs are traded on stock exchanges throughout the trading day at market prices, similar to individual stocks and investment trusts. This provides the liquidity and flexibility of stock trading, with the diversification benefits of mutual funds.
ETFs often track specific indices and are predominantly passively managed, resulting in lower management fees compared to actively managed mutual funds. The ability to trade ETFs throughout the day offers opportunities for tactical trading strategies, such as short selling or using limit orders. However, trading ETFs can incur brokerage fees and the market price may differ from the NAV of the fund's assets.
CHOOSING THE RIGHT INVESTMENT VEHICLE
When deciding between funds, investment trusts and ETFs, consider your investment goals, risk tolerance and preference for active or passive management.
Funds offer professional management and diversification but come with higher fees and limited trading flexibility. Investment trusts provide the potential for gearing and stable management, but their closed-end structure may lead to price discrepancies from the NAV. ETFs offer a blend of flexibility, lower costs and market liquidity, but tend to be passive.
Investors should also consider the tax implications, trading costs and the impact of fees on investment returns when choosing between these options. Understanding the differences and how each investment vehicle aligns with your financial objectives is key to constructing a portfolio that meets your needs.
This Trustnet Learn article was written with assistance from artificial intelligence (AI). For more information, please visit our AI Statement.