How do ETFs compare with mutual funds?

ETFs and mutual funds serve the same general purpose. They provide exposure to particular markets or market segments. So it's not surprising that they share more similarities than differences. Let's talk about the similarities in more detail. By pooling money from many investors, ETFs and mutual funds have greater buying power, enabling them to buy many different securities in large quantities.

This results in greater diversification than an investor can achieve by buying individual shares and bonds themselves. ETFs, like mutual funds, can also provide diversified exposure to many segments of the market. The vast majority of Europe domiciled ETFs are organised and regulated as registered investment companies under the Undertakings for Collective Investments in Transferable Securities, UCITS Directive. This is the same regulatory regime that governs the UCITS mutual funds domiciled within the European Union. Compared with actively managed funds, index ETFs and index mutual funds are extremely transparent. Investors generally know what the holdings are and in what proportion based upon the target index. Particularly when a full replication strategy is used to track this index.

Now let's talk about the differences between ETFs and mutual funds. Orders to buy or sell ETF shares are executed throughout the trading day at market determined prices that change continually. ETFs can also be traded at the day's calculated net asset value or NAV as it’s commonly known. By contrast, mutual fund shares may only be purchased or redeemed at their NAV, which is struck once a day.

Typically, this is the end of day price in the relevant market. Both ETFs and mutual funds charge a total expense ratio, TER, also known as the ongoing charges figure or OCF, which essentially covers ongoing operating costs for the issuer to manage the fund. However, because ETFs trade on exchanges, they also have trading costs that are not explicitly felt when buying and selling mutual funds.

These include commissions and bid-ask spreads, which is the difference between the price at which you can sell or buy the ETF. And what about access, pricing, minimum trade size and transaction costs? With ETFs, shares are bought and sold on an exchange or over-the-counter through a stock broker, platform offering brokerage services, or a market maker. With mutual funds, shares are bought and sold directly through the fund company or through a fund distributor.

With ETFs, buying and selling share prices are set by the market throughout the trading day, and there is a net asset value based on official closing prices. On the mutual fund side, net asset values are determined once per trading day based on official closing prices after financial markets close. With ETFs, there are brokerage commissions and bid-ask spreads on each direct purchase and sale. On the mutual fund side, costs include sales charges, entry/exit charges, or swing prices.