ETFs Versus Unit Trusts: What Should I Invest In?

ETFs (exchange-traded funds) and unit trusts (also known as mutual funds) often get confused because they both offer diversified exposure to the market.

But, there are fundamental differences with significant implications that you should consider when deciding where you should invest your money.

Before we understand the implications of these differences, let’s first understand the key differences between these investment products.

The investment landscape offers a diverse range of financial instruments, yet many products remain inaccessible to some due to challenges such as capital requirements and limited accessibility.

However, the introduction of exchange-traded funds (ETFs) and unit trusts has helped lower these barriers, enabling more individuals to diversify their portfolios and access broader market opportunities.

But what are ETFs and unit trusts, how do they differ, and what should you consider when choosing between them?

An ETF, or an exchange-traded fund, is an index-tracking investment tool that is traded in a public market. Indices are composed of asset classes, such as stocks or bonds. They are typically focused on a particular segment of the market, such as technology, energy, or real estate, or on a particular geography, such as Japan or emerging markets.

ETFs follow these indices to track the market’s volatility. ETFs are traded on the stock exchange just like a security and they are very popular. In fact, in 2016, 14 out of the 15 most active securities were ETFs. Among these, only one was a stock: Apple.

An example of an ETF is the SPDR S&P500 ETF (ticker: SPY), which tracks the S&P500 index. By buying shares of SPY, an investor gets exposure to the performance of the S&P 500.

On the other hand, a unit trust, or mutual fund, is an actively managed investment tool. Like an ETF, it has many securities beneath it, but a key difference between the two lies in how the funds are created.

With a unit trust, individual investors pool their money into a unit trust, and then the fund manager oversees the fund by investing in individual securities, such as stocks or bonds. In turn, the investors of the fund earn proportional ownership of the fund.

Investing in a unit trust is betting on the manager’s ability to pick the best securities, the “winners”, and therefore perform better than the market. Because of their higher cost structure, Unit Trusts need to return 1% to 2% more per annum in order to match the net-of-fees returns of passive funds.

Another notable difference between unit trusts and ETFs is that Unit Trusts are bought and sold through private channels versus the public market for ETFs.

The table below summarises the key sources of differences between these investment products in terms of how they are sold and how they are managed. In practice, these differences typically lead to dissimilar overall returns. How? It comes down to their structure, how they’re managed, and the associated costs.

The figures mentioned here refer to pure, plain-vanilla equity funds. Balanced and fixed-income funds tend to have lower annual management fees.

The data for “unit trust” come from The Cerulli Report - Asian Distribution Dynamics 2015.

To help you better visualise how these differences impact an investor, we’ll delve into the details below.

The price of an ETF reflects the price of the underlying securities within the ETF. Because ETFs are traded on the stock market like security, they are easily sellable, which can give you almost immediate access to your cash.

Unit trusts, on the other hand, are only available to buy and sell after the market closes each day. Additionally, Unit trusts usually have associated entry and switching fees for buying and selling, which makes the investment tool less liquid – and more costly – versus an ETF.

As mentioned above, ETFs track indices of specific asset classes, whereas Unit Trusts can have great diversity in the included asset classes in a particular fund. This is not to say that an ETF cannot be in a portfolio with other asset classes-- it can!

Most major and minor asset classes, markets, and geographies are covered by one ETF or another. Plus, with the introduction of smart beta ETFs and alternative ETFs, such as the IQ Merger Arbitrage ETF, investors will start seeing more and more ETFs with multiple factors of exposure to various asset classes.

When selecting an ETF, though, it is very important to check its size, liquidity, and tracking error. This is particularly true for some of the more “niche” ETFs, which may lose their liquidity feature by being too small and not achieving good trading volumes.

In contrast, unit trusts provide the flexibility to build a portfolio of your choosing without being constrained to a specific tracking function. So, if you are looking to invest in a specific niche that no liquid ETF covers at a given time, a unit trust may be the best way to create a portfolio that has the unique underlying securities you want.

Ultimately, the key difference between an ETF versus a unit trust is that the former offers diversified exposure to a particular asset class at a low cost. While unit trusts still can achieve the exposure, it comes at a high cost. For this reason, unit trusts are better suited to help an investor get exposure to a particular market niche where more liquid and cost-effective products are not available.

Another difference between ETFs and unit trusts lies in their fee structures. Due to the unit trust management’s focus on costly securities selection, fees are inherently higher with these types of investment products. Moreover, unit trust management requires significant resources, which translate to higher fees that are passed on to the customer investing in the managed portfolio.

Additionally, unit trusts usually carry distribution costs, as they’re not available on public markets. Part of these costs for buying and selling the securities are usually included in the management fees, while part of them are charged as “entry” or “exit” fees, which are often referred to as “loads.”

ETFs, on the other hand, operate differently. Because ETFs trade like a security, they do not have loads. Instead, the cost of distribution may be charged directly by the distributor itself, for instance as trading costs by the broker.

By avoiding the active selection of securities, portfolio managers can reduce their costs. This thus allows them to charge management fees that are significantly lower than their unit trust counterparts, which require fund managers to trade stocks continually, also known as active management.

Unit trust managers deploy an active investing strategy, which focuses on choosing which securities to buy and sell at any given time based on a point of view on the future prospects of a specific asset (e.g., will Apple’s stock increase in price or decrease?). This is what's commonly referred to as “stock picking.”

Recently, active fund management has come under scrutiny for its ineffectiveness at outperforming major indices, such as the S&P 500, over a long-term period, resulting in overall lower returns for investors.

According to the mid-2016 SPIVA US Scorecard, 94.58% of US domestic equity fund managers who participate in active fund management have underperformed the relevant passive index benchmark in the past 5 years. Active fund management also is quite costly, as it comes with frequent transaction costs that are deferred to the investor as a fee deducted from his or her investments.

Investors who build portfolios with ETFs are more concerned with the broader picture of long-term returns for an asset class, and less concerned with beating the market by picking the best stocks.

Because an ETF tracks an index, its investment strategy is very clearly laid out by the choice of index and the execution is very cost-effective, as no decision making is needed. This long-term strategy is referred to as “passive investing.”

In a nutshell, each investment product has its strengths and weaknesses. When deciding whether you should invest in an ETF or a unit trust, it’s essential to weigh how their benefits and risks align with your goals, risk tolerance, and investment strategy.

To help you make a more informed choice, we’ve summarised their pros and cons below.

Low cost: One of the key advantages of ETFs is their low cost. As most ETFs are passively managed, they tend to have much lower management fees versus actively managed unit trust. This allows you to keep more of your investment returns over time.

However, this cost advantage isn’t always guaranteed, as it can be affected by the bid-ask spread—the difference between the highest price a buyer is willing to pay (bid) and the lowest price a seller will accept (ask) for an asset.

The cost of ETFs listed on the Singapore Exchange (SGX) can be higher due to limited daily trading volume. During periods of low liquidity, especially in market downturns, bid-ask spreads can widen significantly, resulting in higher costs for investors. As a result, investors may end up paying a higher price to purchase shares or receiving less when selling them.

Liquidity: Should you require the flexibility of having quick access to your funds or entering and exiting the market within the same day, ETFs are ideal as they can be bought and sold at any time during market hours.

Transparency: Since ETFs are index-based, their holdings are generally disclosed on a daily basis, providing transparency about what you’re investing in. You can always track the performance of the underlying index and adjust your strategy as needed.

No outperformance: Given that ETFs typically track indices and lack active management, their returns mirror the performance of the indices, which may leave limited opportunities  to achieve higher returns.

Market risk: Sudden shifts in demand can cause rapid price fluctuations that temporarily push the ETF's price away from its net asset value (NAV).

With an understanding of the pros and cons of ETFs, let's see how unit trusts fare.

Active management: Unlike ETFs, unit trusts are actively managed by professional fund managers, which means you can benefit from leveraging their expertise to make informed decisions rather than spending your own time and resources to do so.

Potential for higher returns: Due to the active management approach, the odds for unit trusts to outperform the broader market is better versus that of ETFs, especially if skilled managers can capitalise on opportunities that passive funds might miss.

Flexibility in portfolio customisation: Unit trusts can offer more flexibility in terms of asset class composition and can provide access to niche markets that might not be covered by an ETF. This can be particularly valuable for investors seeking exposure to unique sectors or regions.

Higher fees: One of the major downsides of unit trusts is their higher fee structure versus that of ETFs. Active management, trading costs, and other fund-related expenses can add up and eat into your overall returns and you’ll likely need to achieve higher performance to cover these fees.

Limited trading flexibility: Unlike ETFs, which can be bought or sold throughout the trading day, unit trusts are typically bought and sold at the close of each trading day. This means you will not have immediate access to your funds, and are unlikely to be able to react to market changes quickly.

Unit trusts were once very popular because they offered similar diversified exposure to the markets. However, it turns out that there are other options, such as ETFs, that can more efficiently achieve desired levels of diversification, and enable investors to apply passive investing strategies effectively. As such, ETFs are increasingly gaining popularity amongst portfolio managers who apply passive investing strategies to their portfolios.

At StashAway, we use ETFs in every customer's portfolio. Their low costs don't cut into returns, their diversified exposure to the markets maximises returns at any given level of risk, and their liquidity and versatility give us the flexibility to face any economic environment. All of this ultimately helps our customers achieve their financial goals faster than with other investment products.

This article was first published on StashAway.

The article was originally published on SingSaver on 28 December 2021 and updated for accuracy on 23 January 2025.

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By StashAway
StashAway is an online investment management company headquartered in Singapore. The company was founded in 2016 and was the first robo-advisor to obtain a full capital-markets services license from the Monetary Authority of Singapore.

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