Index funds vs ETFs and OEICs. What’s the best way to build an index funds portfolio? What’s the difference actually between Index Funds, Exchange Traded Funds, Open Ended Investment Companies? This article will guide you what you need to know. You’re probably familiar with the terms index fund or index tracker, but the devil is in the detail when it comes to investing. As a result, you’ve likely found yourself asking questions such as “are ETFs Index Funds?” “Is an ETF the same as an Open Ended Investment Company (OEIC)?”.
If you’re contemplating your options for investing in an index tracker, it’s essential to grasp the distinctions between the various types of funds that provide exposure to the index. Investment values can fluctuate, and there’s a possibility of receiving returns lower than your initial investment. If you’re unsure about investing, seeking independent financial advice is advisable.
Disclaimer: This is article should not be considered as financial advice. You are responsible for your own investment decisions. When investing capital may be at risk.
Index Funds vs ETFs – Is There A Difference?
Let’s pull in the experts. Vanguard describe an index fund as a Mutual fund or ETF (exchange-traded fund) that tracks the performance of a specific market benchmark—or “index”. Like the popular S&P 500 Index—as closely as possible. That’s why you may hear people refer to indexing as a “passive” investment strategy. This may also include UCITs such as the Vanguard FTSE Global All Cap Index Fund. For a full list of Vanguard Index Funds click here.
This list includes S&P 500 UCITS ETF. Which as you can see by the name is a “undertaking for collective investment in transferable securities” and an Exchange Traded Fund. So as you can see, Index fund is an umbrella term which includes OEICs, UCITs, ETFs and Unit Trusts. Therefore the distinction is not between Index Funds vs ETFs, but between all the different types of Index Funds.
Depending on the investment platform, you may find that funds tend to be structured in a preferred way. For example, Vanguard generally favours UCITs structure, where as Fidelity has more OEICs. Both have a strong selection of ETFs. Fidelity has no less than 400 ETFs. So you are not short of choice when it comes to index fund investing.
Read: You Need To Know Why The Fidelity World Index Fund Beat The Vanguard FTSE All Cap
Index Funds Investing: What’s The Best Way To Track An Index?
Index funds investing is pretty simple at it’s root. However, there are lots of little details that can make investing seem complicated. For example, there are:
- The different investment options that grant exposure to indices.
- The variations between these investment vehicles.
- How to determine which tracker type aligns best with your investment goals.
Imagine you’ve decided to incorporate a passive fund into your investment portfolio. Upon logging into your investment account and searching for ‘index trackers,’ you’re confronted with an extensive list of potential investments. While you may be inclined to select one based on your familiarity with a particular investment provider, it’s important to recognize that trackers come in different forms.
Trackers can manifest as Exchange Traded Funds (ETFs), unit trusts, or open-ended investment companies (OEICs). A comprehensive understanding of the disparities between these fund types is crucial before making an investment decision. This guide will aid you in determining the most suitable tracker for your portfolio.
Read: Everybody Recommends The FTSE Global All Cap But Is This The Best Portfolio Choice?
How Do ETFs vs OEICs and Unit Trusts Operate?
An ETF is a fund that typically seeks to replicate the performance of an index, such as the FTSE 100 in the UK or the S&P 500 in the US. ETFs are traded on stock exchanges, allowing investors to buy and sell them similar to shares in a company. There are two primary categories of ETFs: physical and synthetic. Physical ETFs invest directly in the assets comprising the index, like the companies listed on the FTSE. Conversely, synthetic ETFs use derivatives to gain exposure to a specific market.
FTSE All-World UCITS ETF (VWRL) is a great example of a global ETF, as is the iShares MSCI World ETF. With each fund having the same investment objective of tracking the results of an index. These funds essentially mirror the index they are tracking. If you want to add global stocks to you portfolio, then these index funds provide a diverse array of stocks.
The Fidelity Allocator World Fund W Accumulation is an example of an Open Ended Investment Company, the fund aims to invest at least 70% into funds that use an ‘index tracking’, but also has scope to invest in other collective investment schemes, money market instruments, cash and other derivatives. This means, that whilst a passive index tracking strategy is applied, there is considerably more flexibility for the fund manager to adapt the fund to the market.
Read: Unsurpassed ETFs: Which Vanguard Funds Are The Best?
OEICs vs Unit Trusts
Unit trusts and open-ended investment companies (OEICS) are both a type of investment fund. Funds are collective investments that allow investors to pool their money together to create a large fund investing across a range of different shares and/or other assets such as bonds or property. Index fund investing offers the investor a quick and easy method for diversification.
Vanguard FTSE U.K. All Share Index Unit Trust GBP Acc, which as you can see also applies an index tracking approach and remains an open ended investment company (OEIC). The fundamental difference between a Unit Trust vs an OEIC is that, unit trusts issue units whilst OEICs issue shares. The main significant difference is that Unit trusts quote an offer price (the price to buy) and a bid price (the price to sell). The difference between the two is known as the bid-offer spread. In the case of OEICs only one price is quoted.
Investment Trusts vs Unit Trusts
You may also have stumbled across Investment Trusts. By contrast, to the ETFs and Unit trusts we’ve covered, these are close ended. This means that there’s a limited number of shares. When investors want to buy into a unit trust or OEIC, the manager makes it possible by creating new units and then invests this new money.
Likewise, when investors want to sell, the manager may have to sell investments, or parts of them, so the units can be cancelled. As investment trusts are closed-ended, if you come in as a buyer after a trust’s launch, you can only do so if an investor wants to sell their shares. Examples of Close Ended Investment Trusts are:
- Edinburgh Worldwide Investment Trust Plc (EWI)
- The Global Smaller Companies Trust PLC (GSCT)
- Fidelity Emerging Markets Ltd (FEML)
OEICs vs Unit Trusts:
OEICs and unit trusts share similarities, so we’ll discuss them together. Both are open-ended funds, meaning that when you invest, the fund manager issues new shares in the case of OEICs (since they function as companies) and units in unit trusts, which are subsequently cancelled upon sale. The value of these shares and units mirrors the value of the underlying assets held in the fund.
In addition to tracking an index, OEICs and unit trusts can also compose portfolios invested in stocks, bonds, real estate, commodities, or a blend of various asset classes. Both OEICs and Unit Trusts could be considered part of your index funds portfolio.
What Defines ETFs and Certain OEICs and Unit Trusts as Passive Investments?
Passive investments aim to replicate the performance of a benchmark index, such as the FTSE 100 in the case of an index tracker. They differ from actively managed funds, which strive to outperform a benchmark by employing teams of analysts and researchers and actively trading. Active funds often come with higher costs, while passive funds, as their name suggests, involve minimal involvement in specific investment decisions. Mutual funds in the UK are actively managed rather than passive investment vehicles, as a result they have a higher cost.
Whilst they can all be passive investments, ETFs, OEICs and Unit Trust can be distinguished in four main ways. Transactions, costs, valuation and risk. All index fund investing carries risk and each method of index investing can impact both cost and risk.
| Aspect | ETFs | OEICs and Unit Trusts |
|---|---|---|
| Transactions | Traded on stock exchanges with transparent pricing. | Utilize forward pricing, resulting in varied prices during order processing. |
| Costs | Generally lower annual customer fees; higher online transaction fees. | Tend to have higher annual customer fees; lower online transaction fees. |
| Valuation | Prices influenced by market forces; can trade at premiums or discounts. | Straightforward pricing in tandem with underlying investments. |
| Risk | Counterparty risk in synthetic ETFs if derivative entity fails. | Market risk inherent in the performance of underlying investments. |
Selecting the Right Index Tracker Fund For Your Portfolio
The ‘passive’ method of investing is a popular way of gaining exposure to the stock market. It offers access to a wide variety of share and other assets. Often at a lower cost than ‘active’ investments strategies such as mutual funds.
ETFs and OICS allow investors to take advantage of passive or index tracking strategies. Where the aim is to replicate, or track, the return achieved by a certain stock market index or other benchmark, using computers to maintain a stock portfolio that shadows the target index.
This is because there are some key similarities and differences between Index Funds vs ETFs vs OEICs and Unit Trusts. Here are the headlines:
- ETFs offer transparent stock market trading and lower annual costs.
- OEICs and unit trusts involve forward pricing and relatively higher annual costs.
- OEICs and unit trusts have straightforward valuation.
- ETFs can trade at premiums or discounts due to market forces.
- ETFs carry counterparty risk, while OEICs and unit trusts entail typical market risk.
What ETF, OEIC or Unit Trust To Choose For Your Index Fund Portfolio
Investing can feel overwhelming. Hopefully this has helped to clear up a few questions. For example, the difference between an Index Fund vs ETFs, what ETFs, OEICs, Unit Trusts are. Index Funds and ETFs are terms used almost interchangeably. ETFs are index tracking funds by their very nature.
ETFs are a bundle of stocks that you can buy and sell them just like stocks. They can track an index or a synthetically created index. For example, the iShares Robotics and Artificial Intelligence Multisector ETF. Unlike the Vanguard S&P 500 UCITS ETF, which tracks the S&P 500, this ETF “tracks the investment results of an index composed of developed and emerging market companies that could benefit from the long-term growth and innovation in robotics technologies and artificial intelligence”.
An S&P 500 index fund will buy the stocks in the S&P 500, which the 500 stocks in the US with the largest market cap.
Still confused? There are a few resources I’ve put together to help you on your way.
- 8 Index Funds That Make My Personal Shortlist.
- 5 Balanced Funds for UK Investors.
- 5 Defensive Focused Retirement Style Funds.
- ETF guide – a comprehensive selection of ETFs.
Further Resources
https://www.ii.co.uk/funds/unit-trusts-oeics
