Index tracking: the difference between ETFs and unit trusts

Last updated on 23rd January, 2018 at 03:38 pm

In discussions on index-tracking strategies, the question often arises whether exchange traded funds (ETFs) or unit trusts are the investment route to go. ETFs and unit trusts have a number of similarities in terms of structure, regulation and administration; however, perceptions about them in the marketplace, particularly with regard to total cost, differ substantially.

Differences

They both consist of ready-made packages of shares that deliver the return of a particular market by tracking that market’s index, and both vehicles will attempt to perfectly track the desired index. However, the key difference lies in how these vehicles are accessed, priced and administered.

Trading

Contrary to ETFs, which are listed on a registered stock exchange and trade throughout the day at a range of prices, index unit trusts are not listed and are only priced once a day at the close of business at a unit price. This means an ETF will have a different price during the course of the day allowing investors to take advantage of price swings, while the unit trust will have one price reflecting the nett effect of the day’s movements. Also, unit trusts always trade at the actual market value of their assets, while ETF prices are set by the forces of supply and demand, like any other share, and these prices can deviate from the market value of the underlying shares.

Cost

Accessing these two products is where some hidden costs accumulate. For example, in the case of both an ETF and unit trust, a management fee will apply. However, to invest in a unit trust, there are no additional costs involved as you can go directly to a unit-trust management company that offers index-tracking unit trusts. Alternatively, you can invest via a Linked Investment Service Provider (LISP), which offers access to index-tracking unit trusts (in which case there may be an additional administration fee). On the other hand, when buying an ETF, you will incur additional charges for the following reasons: you generally need someone like a JSE-registered stock broker to help you access the ETF, so there will be a brokerage fee. As ETFs are normally accessible via a trading platform (such as Satrix, etfSA, iTransact, iTrade), there is also a platform charge. In addition, there may also be switching charges, and the investor may be subject to bid/offer spread. Satrix has recently lauched a new online platform, www.SatrixNOW.co.za, which has no annual platform charge, you only pay per transaction. Most ETFs in South Africa are not liquid; therefore a market maker is required to create liquidity. These market makers set the price at whatever level they deem fit, creating a bid/offer spread for investors when they buy or sell an ETF. The bid/offer spread is a cost to the investor. Potentially, when you invest in an ETF on a debit-order basis, there could also be a debit-order fee attached to the transaction.

Legal structure

An ETF is a share traded on the JSE, which is also regulated by the Collective Investment Schemes Control Act (CISCA), whereas a unit trust is a legal savings vehicle regulated by CISCA.

Unit creation, disinvestment

In a unit trust, units are created and cancelled in response to investors’ cash flows, while in an ETF, shares are created by the ETF provider when required. When you disinvest from a unit trust, you will receive your money within 48 hours (in practice it may amount to a turnaround time of five working days). On disinvestment from an ETF you will have to wait a minimum of five days, as trading in shares is subject to the JSE-determined settlement period. The JSE will soon implement a T+3 cycle. This means that the settlement cycle for equity transactions will be changed from its current T+5 cycle to a new shorter T+3 cycle. T+3 refers to the number of business days that elapse from the day on which a transaction takes place, to the day on which the transaction must be settled. For the share to be deemed “settled”, the seller of the share must receive payment and the buyer must take ownership of the share.

Benefits

Despite the above differences, both ETFs and unit trusts have their advantages. For example, the wide range of ETFs available covers every major index, thus offering the investor diversification. In addition, they are transparent and flexible as they can be bought and sold at current market prices at any time during the trading day. Likewise, unit trusts provide easy accessibility, diversification and transparency insofar as prices are published in newspapers daily and performance figures are readily available for comparison. Whatever your choice, be sure you do your homework properly before taking the plunge. By Wilma de Bruin