June 18, 2008 at 3:00 pm by Tom Lydon
Exchange traded funds (ETFs) are gunning for the mutual fund throne.
But as investors try to figure out what’s right for them, it’s important that they know what the differences between the various types of funds happen to be, reports Cathy Pareto for Investopedia.
Mutual funds generally fall into two categories:
- Open-ended fund: These are the most common, as they dominate in both assets and volume traded. Purchases and sales take place directly between the investors and the fund company. The value of the shares are not affected by the number outstanding.
- Closed-end fund: These have a set number of shares and do not issue more shares as demand grows. Prices are driven by demand, not the NAV.
ETFs come in three forms:
- Exchange traded open-end index mutual fund: Dividends are reinvested on the day of receipt and paid to shareholders in cash each quarter. Securities lending is allowed and derivatives may be used in the fund.
- Exchange traded unit investment trust (UIT): These must attempt to fully replicate their specific indexes, limit investments in a single issue to 25% or less and sets weighting limits for diversified and non-diversified funds. They don’t automatically reinvest, and pay cash dividends quarterly. An example of this is the PowerShares QQQ (QQQQ).
- Exchange traded grantor trust: It looks like a closed-end fund, but the investor owns the underlying shares in the companies and has the same voting rights as a shareholder. Dividends are paid directly to shareholders, not reinvested. An example of this kind of ETF are holding company depositary receipts (HOLDRs).
Among the advantages ETFs have over mutual funds are:
- Greater trading flexibility, since they trade all day just like a stock.
- Fees are generally lower. ETF fees range from 0.07% to 1.25%, while mutual fund fees range from 0.5% to more than 10%.
- They have tax advantages for investors, as passively managed funds tend to realize fewer capital gains than actively managed mutual funds.
June 19th, 2008 at 2:45 am
Hi Tom, it would be interesting to know more about the advantages and disadvantages of three types of ETFs you identify. Apologies if you may have already covered this in the past. Thanks.
June 19th, 2008 at 3:57 pm
I, like Bryan, would also be interested in learning more about the advantages and disadvantages of the three types of ETFs. And also, how one can find out which of the types that a specific ETF is. Thanks Tom.
June 20th, 2008 at 1:39 pm
Bryan and Chris,
The first two types of funds listed are the more conventional ETFs that have all the benefits of them you’re probably familiar with by now (tax advantages, transparency, ease of use, etc.). Securities lending and use of derivatives is a fairly common thing, though.
To find out which fund falls under which category, you’ll have to dig into the prospectus or ask the fund company directly.
Grantor trusts are a bit different, and they can be clunky. Dividends are paid in cash, you have to buy them in 100 lot increments and they can be volatile. We wrote a post about HOLDRs recently:
http://www.etftrends.com/2008/05/holdrs-are-very.html
Hope this helps you!
July 22nd, 2008 at 2:12 pm
I also compared performance
http://cheapogroovo.vox.com/library/post/exchange-traded-funds-versus-widely-held-mutual-funds.html