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ETF or Managed fund for long term investment?

Discussion in 'Medium/Long Term Investing' started by Panaman, Jul 5, 2014.

  1. Panaman

    Panaman

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    I’m looking to invest on a regular basis into the Vanguard High dividend ETF for my SMSF and want to add on a regular basis to the investment over a 10 year period, I can invest in 2 ways, either the ETF directly which I buy on the ASX or alternatively buy the Vanguard managed fund of the same name, other than that there exactly the same thing.

    The advantages of the direct ETF is its lower fee cost, so slightly better performance but I do have to pay brokerage each time I buy a parcel so I guess I would only do it every time I have saved up $5000 as that’s a decent size minimum parcel, so maybe only twice a year as otherwise brokerage will eat into what I’m investing.

    The managed fund has a slightly higher fee (Vanguard need to make a buck) but I can add additional funds when ever I want, there is only a $100 minimum, so say $200 a week.

    I’m torn between which option to take, so what would you do and what other pros and cons should I look at?
     
  2. DeepState

    DeepState Multi-Strategy, Quant and Fundamental

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    Re: ETF or Managed fund for long term investment

    Tough choice...but that also possibly implies that the differences between them aren't so great as to have large regret at whatever choice you make.

    Without considering the issue of embedded capital gains/losses within the ETF and underlying fund into which it invests (which is your alternative investment), please consider as follows:

    Management fee of ETF = 0.25bps pa. Underlying fund = 0.40bps per annum. You need to pay brokerage to buy ETF = 0.1% per transaction if $20k or more. Or, if investing in $5k blocks via online broker = $20/5000 = 0.4% per transaction. Underlying fund requires buy/sell spread = 0.25/0.1bps. Given you are thinking of investing in small lots, if buying the ETF, you would not need to be a liquidity demander and bid via 'market-limit' execution.

    If you try various combinations of initial capital and cash flow, the ETF is superior if you have:
    + a large initial amount and zero or negligible subsequent cash flow.
    + a small initial amount and massively growing cashflows (when you get large enough, you can create units in the ETF)

    For the underlying fund to make sense your cashflow pattern must be such that it grows massively against the savings amount accrued. Various other unrealistic things need to happen as well.

    Essentially, the ETF is the way to go...ignoring tax.

    When you include tax considerations ETFs are more vulnerable turnover via creation and destruction of units which trigger tax events and result in tax bills to you even though you didn't do anything to actually trigger them. If a whole bunch of big investors decide to sell out via in specie, their activity will destroy units and create tax events. Big investors who are tactical in nature prefer ETFs to the underlying fund to limit transaction costs. Given this is a specialised fund, though, my guess is that it would be less of an issue than for market capitalisation oriented ETFs. But I cannot be sure.

    It may also be that the embedded/unrealised-gains/realised-losses in the ETF vs underlying fund favour one over the other. You'll need to call the help line to get that info as it is not readily available and you might not get it because it would represent the provision of inside information if not widely released.

    Clear as mud.
     
  3. Panaman

    Panaman

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    Thanks for the time to reply :) but yes…………………………..clear as mud and a bit more confused although got the gist of what your saying(I think) :confused:

    :xyxthumbs
     
  4. joku

    joku

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    Is there a reason you aren't considering LIC's?

    LIC's aren't at the cheapest levels right now since price growth has been above equity growth significantly in the last few years, it began from fairly healthy discount levels so they aren't terribly priced, just not overly attractive at the minute. I'd be tempted to stick to Vanguard or SPDR ETF's for the moment, but longer term I prefer LIC's over ETF's. LIC's have their own set of disadvantages - market price fluctuation and restrictive buy/sell liquidity. Dividends are much more steady/predictable and you don't have to worry about personally having to pay a tax bill on gains you haven't personally realized as retiredyoung explained can and does happen with funds.

    By LIC'S I mean a specific class of conservative mostly-passive, index - like, low fee LIC. Eg. AFI, ARG, MLT, AUI, DUI. There's about half a dozen more that also mostly fit this description but those are a good start point for research.
     
  5. DeepState

    DeepState Multi-Strategy, Quant and Fundamental

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    Whoops, the mud was thicker than I hoped. It's a tough/easy call. This is a wash, for this circumstance. The choice of which way to go depends on a bunch of assumptions whose break-even points for this decision are well within the 'yeah...whatever' boundary. You actually can flip a coin on this. There isn't much more analysis that can be done. As mentioned before, risk of regret won't be large, and it will just come down to luck for the most part. So don't beat yourself/me up in 10 years time if the other alternative might have been fractionally better in the end.

    Here's a coin for you to toss:

    https://www.freakonomicsexperiments.com/

    In relation to LICs, it is worth thinking about. Their propositions would generally be different to your objective of underlying high yield investments. But...it is probably worthwhile just taking look at it before making a decision. You may be swayed in that direction and very reasonably so.
     
  6. jet328

    jet328

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    Re: ETF or Managed fund for long term investment

    If we have another large stock market decline like the GFC and lots of people exit the ETF to return to safer asset classes, would the ETF track the index since tax has to be paid?
     
  7. DeepState

    DeepState Multi-Strategy, Quant and Fundamental

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    Re: ETF or Managed fund for long term investment

    Great question (not that your other questions and posts aren't).

    The answer, I believe, is 'it depends'.

    The ETF will be structured so as to very closely match whatever the underlying index actually is. In the case of the Vanguard funds, the ETF is actually a type of unit holder in their main fund. Hence, the ETF will match the main fund. Vanguard will basically fully replicate the index (that's their approach). Hence the main fund will move in line with market on a pre-tax basis. The NAV of the ETF will do likewise. The price of the ETF will be kept in alignment to the NAV via the market maker obligations. Everything performs pretty much in line with the underlying index.

    There is always variation from the index, which does not pay tax, and the underlying in an after tax sense. It depends on the tax parceling and the full history of purchases and sales since inception. Hence, if SSGA managed this exact index in the exact same way as Vanguard, it would be a total freak if their after tax performance were identical.

    What happens in a GFC? People can sell the ETF without causing unit destruction. So they simply sell to other buyers via standard market mechanisms. If that is the case, there is actually no turnover in the ETF. Everything is sweet.

    If they sell out of the ETF via in specie, it leads to tax events. The impact of these is dependent on the full history of transactions as mentioned before. Given the punters generally buy high and sell low, what tends to happen is that tax assets get created! But, of course, that is not assured.

    What is the potential for mass ETF in specie redemption? In this case, which is a specialist fund, I am going to guess that there is not a whole lot of single-account style insto money in there. There would possibly be exposure via Wrap or Platform. Money flowing out of these would not generally be achieved via in specie. Hence they would not disturb the tax parcels much. If they don't like it, they sell the ETF to buyers. This is just the same as dumping your Acme Corp stock to liquidate it. Someone else buys it.

    As a holder of the ETF, not much goes on from these activities.

    Bottom line, the pre-tax performance will remain closely matched to the underlying index. The post-tax will be different from the underlying index which is pre-tax. How different and in which direction are open questions. Given the propensity of the market and retail behavior in particular (the key market for such funds), there is every chance that a GFC event which causes some unit destruction would actually generate tax assets.


    Disclosure: I am a holder of STW-AU (SSgA SPDR ASX 200). I am a holder of certain Vanguard funds. The combination of the two represent <5% of our assets. I have no other relationship with either.
     
  8. sydboy007

    sydboy007

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    ETFs can help you to invest in a particular sector of the economy, or internationally in an easy way, especially if you're more interested in a particular sector or country.

    LICs are quite good for domestic shares and some international investments, but I don't think internationally they allow as much targeting of where your money will go as ETFs.

    I'd say managed funds would be your least best option just because of their generally higher fee structure, though some LICs are on the expensive side with management fees and performance fees if they beat the index (not all charge performance fees).

    Just make sure you have a good idea of what each option will cost you, because an extra half to one percent in fees adds up after a few years.
     
  9. joku

    joku

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    Agree :xyxthumbs

    Agree :xyxthumbs Unless you really can't trust yourself with building up a couple of grand of cash between purchases, funds don't have all that much going for them. They need to outperform to keep on par, and some do, which might be worth further investigation, but keep in mind that fund performance is dubious because managers can practice culling their poor performing funds to make historical performance look better, fund unit holder ongoing taxation isn't properly presented whereas LICs are post ongoing tax, and not all fund performance data is post fees.

    This statement is true but could easily be taken the wrong way. A (small) handful of Australia-invested LICs have lower fees than any Australian-invested fund or ETF. LICs win at low fee and low tax. There are (much) more expensive versions, just as there are very expensive ETFs and (ultra) expensive unlisted funds. Neither LICs, ETFs or unlisted funds can be safely generalized, and I listed some of the lower fee LICs in my original post for this very reason.
     
  10. 80shark

    80shark

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    How about a passive managed fund like Vanguard Australia?

    That's what I use and very happy with them.

    The only one negative thing I did not consider is that you'll pay tax for the capital gains at the end of the year, rather than at sale time. If you're doing well it can add up.

    But I guess that's the case with any managed fund vs stocks/etfs
     
  11. 80shark

    80shark

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    PS: scratch my tax comment, no difference in tax treatment between managed funds and ETFs
     
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