Exchange Traded Funds vs. Managed Funds. Which investment do private investors prefer?

Table of contents

Table of contents

List of abbreviations

1 Introduction

2 What are Exchange Traded Funds?

3 What are Managed Funds?

4 Research method

5 Evaluation method

6 Evaluation – Which investment class is preferred?
6.1 General results
6.2 Exchange Traded Funds
6.3 Managed Funds
6.4 Comparison

8 Conclusion

Bibliography

Internet sources

Appendix

List of abbreviations

DAX Deutscher Aktienindex

ETF Exchange Traded Fund

MF Managed Fund

NAV Nat Asset Value

1. Introduction

“If you don`t find a way to make money while you sleep, you will work until you die.”<sup>1</sup> This quote belongs to the US star investor Warren Buffet and inspires people all over the world to invest their money to get gain in value as well as passive income. To reach these goals people put their savings in several investment assets within a special kind of market. The capital market is a place with millions of participants, who invest in shares, bonds, properties, currencies, commodities and many more alternatives. Even digital currencies like the cryptocurrency Bitcoin is getting an interesting instrument to invest in. The universe of products that promise monetary benefits to investors is quite big and difficult to oversee. One important asset class, which has not been mentioned in this text yet, does belong to funds. This term paper wants the reader to get an idea of what asset investors would prefer if they had the choice between Exchange Traded Funds and Managed Funds. Therefore, the author starts with giving an overview about these two assets including basic information, special key facts and some numbers, that show the relevance within the current capital market. After that the term paper includes a chapter about the research method as the research question will be answered with a questionnaire, which will give subjectively information by volunteer private investors. This part will be followed by an explanation about the evaluation method, at which the collected information will be analyzed and compared. Then the questionnaire`s results will be evaluated, separated into general part, ETF-part and MF-part. With the help of a self-created scorecard the preference of the interviewed people will be shown. Last but not least the author will give a conclusion, in which he will shortly summarize the content of the previous chapters and will show the final result regarding the research question.

2. What are Exchange Traded Funds?

Exchange Traded Funds, short form ETFs, is an investment instrument, which consists of several assets. It is traded at the stock market similar to bonds, stocks and certificates. The assets within the fund can be numerous to have a high diversification rate and to be independent of movements from single stocks. There, for example, can be like ten assets in the ETF or one thousand. As Exchange Traded Funds try to copy other existing indices like one of the most meaningful US index S&P 500, their performance does correlate with the index one very closely. Also, ETFs can be combined within a single Exchange Traded Funds so that e.g. a silver ETF and a gold ETF together try to represent the performance of important precious metals. To get an idea of the popularity of ETFs it must be mentioned, that since the year 2000 the accumulated asset value has risen with a factor of 47 and will further raise to a number of 12 trillion dollars until 2023. With a collection of a few thousand ETFs an investor has the possibility to invest into environmental-based funds, which invest in new trends like hydrogen power or self-propelled cars. Some of the most important characteristics are the low cost compared to other assets like e.g. mutual funds. In average the costs are only about 33 percent in this case. Therefore, ETFs are not managed by a professional fund manager. As already mentioned shortly, Exchange Traded Funds can be traded flexible over the day during general trading hours like stocks and bonds. This enables the investors to buy this asset in the morning and sell it in the evening. These kind of trade activities can be repeated within one day several times. Unlike with mutual funds you can buy ETFs without considering a minimum amount.² Investors, which have a more complex trading strategy than just trading for the current market prices have the possibility to trade Exchange Traded Funds with several trade types like market, limit and stop orders. Even margin buying is an option regarding ETF trades. ETFs can also perform the opposite of an index and are then called inverse funds. Like derivatives an investor is able to trade with leverage by buying an Exchange Trading Funds including a factor to have higher chances of profits – that of course implicates also higher risks.³

3. What are Managed Funds?

Managed Funds, which are also called Mutual Funds, do exist within the capital market for about 60 years as banks, brokers and other financial institutions charged a lot commission when their customers were doing trades at the stock market. For retail investors that was very unattractive as diversifying their portfolios was quite expensive because of the huge number of necessary trades implicated high trade commissions. Mutual funds offer the investor to have a cheap possibility to access diversification without many to-dos but at the same time having a stock selection benefit. The assets of a Mutual Fund are managed by a professional manager or management company. The management does regularly check the fund`s assets and restructure the fund to react to changing market conditions and trends. This implicates costs of around 1.5 – 3 percent per year independent whether the Managed Fund performs well or not.<sup>4</sup> Paying this commission, which are only the running costs, but do not include the buying costs, raises the investor`s expectations to receive an outstanding performance better than any other standard index. Mutual Funds can only be traded for the net-asset-value-price (NAV-price). As the NAV is fixed only once per day by calculating with all the asset´s values, buy and sell orders are collected and executed for the next day`s NAV. This implicates an issue of non-flexibility trading wise. This forward pricing is because the funds management has to make sure that there is enough cash value to pay the sell-investor.⁵ The largest asset managers managing mutual funds are BlackRock Asset Management with total managed assets of around 5.2 trillion USD and Vanguard Asset Management with around 4.2 trillion USD.⁶ To get an idea of how many asset value is managed in Mutual Funds by investment companies, the following figure shows the development in the United States.

Figure 1. Mutual Fund assets held by investment companies

Abbildung in dieser Leseprobe nicht enthalten

Source: https://www.statista.com/statistics/255518/mutual-fund-assets-held-by-investment-companies-in-the-united-states/, Accessed on 20/02/2020.

It can be recognized that the number of managed assets in mutual funds has risen over the last 20 years by a factor of about three. In the years of financial and political crisis the number was lower compared to the respective previous year as stock markets crashed and so the values decreased. Nevertheless, the trend still seems to be positive.

4. Research method

As the research question is suitable for being answered by subjective perceptions, the author decided to do a questionnaire. Due to the financial topic, mainly persons from the financial sector were interviewed in order to obtain a meaningful result. However, the link leading to the online questionnaire was also sent to a few people, which have not obviously to do with the finance topics every day. The link was online for a total of 30 days what was at the same time the possible duration to fill out the questionnaire. In total 60 people were asked to fill out the questionnaire – in the end 44 fully filled ones were submitted. The author used the website www.umfrageonline.de to create and send the questionnaire. It includes 18 questions, of which the first questions are open-ended or multiple choice to get as much information as possible. After that, the question`s structure changes to be single choice ones to have a good possibility to evaluate and categorize the answers. That shows, that the structure of the questions is funnel-shaped to get as well superficial as well as detailed information. The first questions want the respondents to show their interest and knowledge in investing. The further ones ask about level of knowledge regarding Exchange Traded Funds as well as Managed Funds before forcing the filler to decide between these two assets, which is the most important part to answer the term paper`s research question. In the next chapter the author shows how the results will be evaluated.

5. Evaluation Method

The term paper uses the questionnaire`s results to answer the research question whether private investors prefer Exchange Traded Funds or Managed Funds. Therefore, the answer will be categorized as they belong to ETFs or to Managed Funds or are general results. Additionally, the answers will be counted and scored so that there is a transparent comparison between these two assets. Each answer given, which argues for Exchange Traded Funds, will give one Point to the ETF-Scorecard. For Managed Funds it will be the other way around. Questions, which do not aim for a decision between both fund variations, will not be considered in the scorecards. As the author gives the answers different significance, there will be also given three points for specific answers. If a result is very closely like around 55% choose option A and the remaining 45% choose option B the given score will be halved. In the end, the scores will be compared, which will then lead to the conclusion.

6. Evaluation – Which investment class is preferred?

This topic is cut into three sections to get clearly arranged results to allow a comfortable evaluation. The first part will show general results (Question 1-4) followed by Exchange Traded Funds. Here the relevant questions are 5-7. Last but no least there will be an evaluation part regarding Managed Funds having a look to questions 8-10 to round this off. Questions 11 to 18 are so constructed that one of the answers speaks in favour of Exchange Traded Funds whereas the other choice argues for Managed Funds. The answer possibilities are kind of characteristics of the respective investment instrument. These characteristics are already proved in chapter two & three and will be used in this one as well.

6.1 General results

The questionnaire`s questions one, two and three aim on answers that do not directly belong to any asset class but shall give information about interest, prior knowledge and trading activity of the respondents. Having a look at the results, 40.9% say that investing is an important topic while 43.2% sometimes spend time for personal investments. Only 15.9% do not care about investing at all, what shows that most of the interviewed people do take this as a serious topic in their daily lives.

The interviewed people with majority know shares as 88.6% of them answered to that effect. Also, with a range of 50% to 65.9%, they know currencies, bonds, commodities and properties as investment instruments. Funds, which is the most important information regarding the research question, are known by 79.5%, so that there is a meaningful number of 35 people having heard or having even more information about this asset class. A quarter of all participants stated that they know further assets as there were suggested in the questionnaire. For example, cryptocurrencies, which are a quite new investment product as well as the for a long-time known investment class called derivatives were mentioned. The following figure shows the complete results with bars to highlight the absolute difference.

Figure 2. Investment Classes

Abbildung in dieser Leseprobe nicht enthalten

Source: Compare Appendix 1

Of all 44 respondents 68,2% answered that they had traded at least once within the last year. So, only 14 people did not show any trading activity in this period of time. Question four wants the respondent to state, whether he is aware of the difference between Exchange Traded Funds and Managed Funds as this could be an important factor to choose between these two assets. A majority of 36 people submitted with yes, whereas 8 people clicked on the no-button.

6.2 Exchange Traded Funds

In this chapter the author wants to evaluate all answers given in the questionnaire that belong to ETFs. Before having a look at the answers that give the asset points for its scorecard, there are questions five to seven. To get an idea of what knowledge the interviewed people have regarding Exchange Traded Funds there were four possible choices. 40.9% of all answer knowing important details whereas 38.6% claim that they are experts in Exchange Traded Funds. About a fifth have either heard about the term but do not know any details or have never heard about ETFs at all. It shall be noted that every fourth respondent knows about it, which is a lot. Most of this group has not been advised by a professional as only 25% stated that they had to do with a professional regarding ETFs. To get an overview how many asked people do own the asset, the author created question seven. Here the result is very balanced as only a little more than half admitted they do not own ETFs. Having to make a decision between trading an instrument that has low running costs or trading one including a professional management, the respondent decide for the first option. That will be a point for ETFs as they indeed do not have a management but have lower running costs than Managed Funds. Not arguing for Exchange Traded Funds, the interviewed people prefer having an investment product with a possible damage limitation in falling markets more than one with low total costs. The next result again shows that the respondents do not think that professional management is that important for them. Instead of this, they want a high flexibility in trading the asset, which ETFs implicate. Performance seems not to be more important than low total product costs as only a minority would prefer an investment, which is able to beat the performance of a specific index like the DAX or Dow Jones.

A majority of about five percentage points consider the possibility trading with the general trading hours being more important that having ensured reaction to changing economic trends without any to do for the investors. ETFs can be traded flexible to current market prices like stocks, bonds and other assets whereas funds are traded at a specific point of time whereby the price fixing mostly is one another day in the future. That is also confirmed in question 16, where selling today for a known market price with trading costs is more popular than trading without costs but receiving the next day`s price. The cost factor for the group of respondents is less important than price transparency. The interviewed people accept a good fund`s management including extra costs as well as no management with no costs, so that there will be half a point for each asset in the scorecard. Last but not least question number 18 leads to a clear decision between Exchange Traded Funds and Managed Funds. 65.9% state that they prefer ETFs, if they had a choice between both assets. This result will give three points to the scorecard as well as it will serve as an evidence.

6.3 Managed Funds

Now the author will show the results regarding Managed Funds to get an idea, how it will be different to ETFs. Analog to questions five to seven for Managed Funds there are questions eight to eleven, which answer kind of general questions regarding knowledge and ownership of this asset. Asking what knowledge there is, the interviewed people mainly answer with having at least awareness of important details. About a third state that they even know very much about Managed Funds. So, in total only around 14 % do not know this asset at all or have only heard about the term. 36.4% have been advised about Managed Funds by a professional whereas 63.6 % have not. That shows that similar to ETFs the majority does not look for professional advice regarding investment choices – at least regarding these two assets. 17 people, what is a percentage rate of 38.6 %, state that they are invested in Managed Funds. The rest does not have a monetary engagement in this asset. For the questionnaire`s respondents the attribute of having a professional management doing an investment seems not to be that important. In a direct comparison they prefer low running costs and high flexibility in buying and selling the asset, which both are characteristics of Exchange Traded Funds. The first half of a point for MF is due to the fact that 52.3 per cent like having a possible damage limitation in falling markets. That means that when markets drop because of e.g. political or environmental happenings a funds manager could intervene and stop the fund`s assets to fall to much in price. This attribute for a little majority is more important that the strength of ETFs – low total costs. Although in question 14 they again prefer the special characteristic of low total costs. The other option was having an investment, that is able to outperform a specific index like the DAX. As Managed Funds are actively managed, which means that stocks within the fund are traded regularly, there is a possibility to beat the performance of such an index whereas ETFs mostly correlate with indices.

Professional Management implicates a reaction to changing economic trends without any to-do for the investor. If e.g. car manufactures decide to build cars with batteries instead of gasoline engines, a fund could change its assets to participate in this trend. This flexibility is nearly as important as the possibility to trade an investment product immediately within general trading hours, which is one of ETF`s characteristics. Managed Funds can mostly be sold once a day for an unknown respectively future market price. This is also something the interviewed people would neglect as 81,8% would choose to have the trading flexibility what an ETF implicates. As already mentioned in chapter 6.2 the respondents prefer ETFs, if they had the choice between both assets.

6.4 Comparison

As in the two previous chapters the questionnaire`s results regarding Exchange Traded Funds and Managed Funds have been evaluated, this part wants to compare both assets including their scorecards. As the answer choices are respective characteristics of either ETFs or MFs, the author wants to show a categorization in the following overview:

Exchange Traded Funds:

- Low running costs
- Low total costs
- High flexibility in buying and selling the asset
- Possibility to trade immediately within general trading hours
- Selling today for a known market price with costs
- No management with no extra costs

Managed Funds:

- Professional management
- Possible damage limitation in falling markets
- Beating the performance of a specific index
- Reaction to changing economic trends without any to-do for the investor
- Selling today for a not known market price with no costs
- A good funds manager that manages the funds in the interests of the investor, but triggers extra costs

The scorecards are created by the author himself using Microsoft`s office tool named excel. The following figure shows the scorecard:

Figure 3. Scorecard

Abbildung in dieser Leseprobe nicht enthalten

Own figure

The scorecard shows questions 11-18. In the second and third column there are the respective result in per cent, before having the weighting in the fourth column. Here it can be seen that the author has weighted every question with a factor of 1 except of question 18, which was weighted with 300%. In the last two columns there are the points for each asset based on the respective results and weightings. Exchange Traded Funds have scored eight points whereas Managed Funds have only scored one point. Also, the most meaningful result, which is based on question 18, is in favor of ETFs. That the interviewed people directly stated they prefer Exchange Traded Funds is another confirmation of their preference.

8. Conclusion

After explaining basic data as well as mentioning key facts about Exchange Traded Funds as well as Managed Funds, the term paper explained the used research method, which showed how the research question was answered. That chapter was followed by describing the evaluation method before starting to practical evaluate the questionnaire`s results. The general results pointed out that the participants have as well good prior knowledge regarding investment instruments as well as regular trading activity. Also, the majority of the interviewed people stated, that they know the difference between Exchange Traded Funds and Managed Funds. That was a good initial situation to look at the asset-based results. Here the respondents decided to prefer ETF´s special characteristics way more than Managed Fund`s ones as the final score was eight to one. Indeed, the evaluation is unambiguously on favor of Exchange Traded Funds, what the self-created scorecard in chapter 6.4 proved. So, all in all the term paper`s research question can be answered that private investors prefer Exchange Traded Funds as the top features are low total costs, high trading flexibility and price transparency. The numerous features of Mutual Funds do not suffice to beat these of ETFs. It seems that the special benefit of Mutual Funds, which obviously is the active professional management, is no must have for the asked group of people when doing an investment. Nevertheless, a part of the questionnaire`s respondents own Mutual Funds. That all being said, the author hopes to have helped the reader on the one hand to understand what other private investors think about investing, especially regarding Exchange Traded Funds and Managed Funds, and on the other hand to get enough information to form an own opinion regarding this topic.

[...]

¹ https://www.awakenthegreatnesswithin.com/35-inspirational-warren-buffet-quotes-on-success/, Accessed on 14/10/2019.

² Compare Forbes, Invest with a purpose, 2019, p. 71-72.

³ Compare Blakey, P., Wireless Investor, 2007, p. 28-29.

⁴ Compare Blakey, P., Wireless Investor, 2007, p. 28-29.

⁵ Compare Haslem, J., Mutual Funds, 2010, p. 22.

⁶ Compare https://www.statista.com/statistics/322452/largest-asset-managers-worldwide-by-value-of- assets/, Accessed on 20/02/2020.