ETFs vs FoFs - Picking the Right One According to Your Financial Goals
When 32-year-old Rajat was contemplating his investment options to build a diversified portfolio, he came across two instruments to do so — exchange-traded fund (ETF) and Fund of Funds (FoFs). Though both seemed the same at first glance, a little more homework made Rajat realise that they weren’t. Indeed! ETFs and FoFs are different in various ways.
Understanding the difference between an ETF and FoF is crucial for choosing the one best suited to your goals.
What is an ETF?
An exchange-traded fund or ETF consists of a basket of securities you can trade on stock exchanges, similar to stocks. As trading happens on stock exchanges, the value of ETFs depends on demand and supply, and their prices fluctuate during trading hours.
What are FoFs?
FoFs, on the other hand, are mutual funds that invest in other funds. Note that mutual funds invest in stocks and securities of different companies. However, FoFs pool money from investors and invest in various mutual funds, thus creating a diversified portfolio. These mutual funds can be of the same fund house or different houses.
ETF vs FoF: Key differences
The table captures the differences between an ETF and FoF on various parameters:
| Parameters | ETFs | FoF |
|---|---|---|
Structure | Consists of a basket of stocks, bonds and other securities | Consists of a basket of diversified mutual funds |
Price | Traded at market price | Traded at their net asset value |
Liquidity | High liquidity as it is traded similar to a stock | Has relatively low liquidity as not actively traded |
Management | Tracks an index and hence passively managed | Has active management and the fund manager chooses fund schemes to invest as per the fund’s objectives |
Associated costs | Comparatively lower costs due to passive management | Higher costs due to active management |
Need for Demat account | Requires Demat account | No need for a Demat account |
FoF vs ETF: Picking up the instrument as per your financial goals
Here, you have an important choice to make. Both ETFs and FoFs can play a vital role in your portfolio. You can pick either of them based on these goals:
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Access to quick liquidity
If you want quick liquidity to address any potential emergency, you can opt for ETFs. You can quickly buy and sell them as they are traded like individual stocks. Therefore, you can get funds on short notice when needed.
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Intraday trading opportunities
Intraday trading involves buying and selling securities on the same day. As ETFs are traded like individual stocks, they give you intraday trading opportunities, which is not the case with FoFs.
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Benefit from management style of several funds
Every fund manager is different and has his/their own management style and choice of securities. If your goal is to benefit from the management style of several funds, you can opt for FoFs, as they invest in different mutual funds.
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Generate alpha through investments
If you seek to generate alpha from your investments, i.e., returns more than the broader markets or the benchmark index, you can opt for FoFs. This is because ETFs track and mimic a particular index while trying to replicate its returns. Alpha generation can come in handy while planning long-term goals like children’s education, retirement, etc.
Wrapping it up
While ETFs and FoFs are different in their ways, choosing either warrants due diligence and factoring in long-term returns. Both can help you build a diversified portfolio and invest while keeping your goals and risk tolerance in mind. If you prefer a more hands-off investment approach, you can opt for FoFs. On the other hand, if you want a passive investment approach, you can opt for ETFs.
Disclaimer: This article is for informational purposes only and does not constitute financial advice. It is not produced by the desk of the Kotak Securities Research Team, nor is it a report published by the Kotak Securities Research Team. The information presented is compiled from several secondary sources available on the internet and may change over time. Investors should conduct their research and consult with financial professionals before making any investment decisions. Read the full disclaimer here.
Investments in the securities market are subject to market risks, read all the related documents carefully before investing. Please read the SEBI-prescribed Combined Risk Disclosure Document before investing. Brokerage will not exceed SEBI’s prescribed limit.
