ETFs versus funds: how do they compare?

ETFs have been growing in popularity in recent years and now for the first time they have been included alongside open-ended funds in the same sectors, making it easier to compare the performance. 

A total of 530 Exchange Traded Funds (ETFs) have been added to the Investment Association’s various sectors. This makes it more straightforward to consider whether to invest in them rather than an active or passively managed open-ended fund operating in the same region. 

ETFs have been growing in popularity in recent years as more investors have opted for low cost index trackers, but the trend could have further to run. They currently typically account for 10-20% of wealth advisor portfolios, a figure that is expected to double in the next four years. 

The simplest ETFs are very similar to passively managed open-ended funds in that they follow the performance of a broad market index and have a low fee, although they have the advantage that they can be traded throughout the day. There are also plenty of thematic options such as the iShares Global Clean Energy ETF, as well as smart beta alternatives that can be used instead of an actively managed fund. 

Efficient market hypothesis

Some indices are harder to beat on a consistent basis than others, with a prime example being the US, which is generally reckoned to be one of the most efficient equity markets in the world. This would suggest that it would be a good area to use a passively managed fund or ETF, but the data doesn’t support the theory. 

Of the 194 products listed in the North America sector there are two standout performers over the last five years and they are both actively managed with a strong growth bias: Baillie Gifford American, with a gain of 409.7%, and Morgan Stanley US Growth, which is up 344.8%. The next best performer is more than 100% behind, with the top ETF being US Equity Opportunities UCITS, which tracks the performance of the largest 100 US stocks, with a return of 162.6%. 

It is not until you get down towards the end of the first quartile that you run into a swathe of ETFs and tracker funds linked to the MSCI US index with five-year gains of around 127%. The S&P 500 trackers appear just below this at about 123%. 

What about the UK?

The largest area in terms of choice is the UK All Companies sector, which, according to FE Trustnet, contains 246 different funds and ETFs. There are three actively managed products that over the last five years have more than doubled investors’ money. They are MI Chelverton UK Equity Growth (175%), Slater Recovery (129.2%) and Slater Growth (103.9%). 

Scrolling down the list, the best passively managed fund is HSBC FTSE 250 Index, which is ranked number 65 with a return of 50.5%. It is closely followed by a couple of other passive funds linked to the same benchmark, then the Xtrackers FTSE 250 UCITS ETF, which is up 49.2%. 

All of these products invest in the UK stock market, but there is a real mix of active and passive, large and mid-cap, growth and value that will all affect the relative performance. On the passive side there doesn’t seem much to choose between the ETFs and equivalent tracker funds, whereas the active managers can add significant value, although the majority tend to lag behind the index after deducting their fees, so it really comes down to whether you want to take the risk of trying to identify the winners in advance.