Mutual Fund vs ETF: How Each One Reaches Your Account

A mutual fund unit and an exchange traded fund (ETF) unit differ in how a portfolio gets in and out. One is transacted with the scheme itself at a value struck for everyone at once; the other is transacted with another holder on an exchange at whatever price is on offer. The counterparty decides the price obtained, the account required and the cost one holder's dealing puts on the others.

Three results are carried in rather than rebuilt. The four route comparison settled the lines any delivery route is answered on, and price against value settled that a traded price and the value behind a unit are two different quantities. Thresholds, cut-offs, charge limits and duties belong to the bodies that set them, and are routed there.

The worked example throughout is the Anantara Multi-Asset Portfolio, an invented discretionary mandate of Rs 500 crore run for an invented charitable endowment. Rukmini Deshpande chairs the endowment's investment committee and Faiz Ahmad Ansari runs the mandate. Its stated policy weights are equity 60.0 per cent at Rs 300 crore, fixed income 30.0 per cent at Rs 150 crore and cash 10.0 per cent at Rs 50 crore. Actual weights drift between one rebalancing and the next.

What exactly is each of these two things?

A household wants a sack of rice. The household can walk into the mill and take a sack weighed out at the posted rate for that day, the rate every household walking in is given. Or it can buy a sack from a neighbour, at whatever price the two of them settle on. The rice is the same rice. Only the person on the other side changed, and everything else changed with it.

A mutual fund and an exchange traded fund are two delivery shapesA way a portfolio reaches the person or institution whose money it is. A delivery shape describes the route and the plumbing, not what the portfolio contains. rather than two strategies, and the difference between them is a difference in route. Neither name reveals what is held; both can follow a narrow list or a wide one. Comparing them as though one were a portfolio and the other a different portfolio is the first wrong turn.

A comparison that starts before both sides are defined is an argument rather than a comparison. A mutual fund is a pooled delivery shape in which many holders' money is invested together as one block, and a holder gets in or out by transacting with the arrangement itself. No second person is involved: the scheme is on the other side.

An exchange traded fundA pooled holding whose units are listed on an exchange, so that a holder gets in or out by trading those units with another holder rather than with the scheme. is a pooled delivery shape whose units are listed. A holder gets in or out by trading those units on an exchange with somebody who already holds them or wants to. The scheme is not on the other side. Another holder is. Both are pooled and both give a claim on a share of what is held rather than on any particular security inside it, and that similarity is why the difference gets missed.

Who is on the other side when a holder transacts?

From one sentence the rest can be derived rather than memorised. In one shape the counterpartyThe party on the other side of a transaction. Whoever it is decides what has to be true before the transaction can happen and what price it happens at. is the scheme, and in the other the counterparty is another holder, and every remaining difference between the two is a consequence of that one line. It is one fact with six children rather than seven unrelated facts.

The derivation runs as follows. If the scheme is on the other side, it has to accept the holder's money or find that money, so the transaction can make the scheme buy or sell; if another holder is, nothing the holder does reaches the pool. If the scheme is on the other side, a value has to be struck, and striking one for everybody transacting at that moment is the only workable way to do it; if another holder is, the two parties settle a price and it is nobody else's. Dealing with another holder also means finding that person and settling with them. The exchange is where the finding and the settling happen.

Transacting with the schemeGetting in or out by dealing with the pooled arrangement itself rather than with another holder, so that no second person has to be found. means the transaction happens on the scheme's own cycleThe regular rhythm on which transactions with a scheme are grouped and struck together, rather than one at a time as each arrives.. Everything arriving in the same window is handled together. The arrangement is the somebody, so no question arises about whether anybody will deal with the holder. Trading on an exchange means the transaction happens when another holder is willing, at the size they will do.

Neither shape is faster than the other in any general sense, and the useful difference is in what has to be true before a transaction can occur at all. A reader who converts that into a claim about speed has replaced a structural difference with a performance claim, and no measurement of either shape's speed sits in the record.

What price does the account actually get?

Back at the mill, the household arriving at nine and the one arriving at four carry away rice struck at the same posted rate. Buying from a neighbour brings no posted rate, only what the two parties agreed.

Transacting with the scheme puts every holder transacting for the same cycle onto one value. Trading on an exchange gives the account whatever the other side would accept at that instant. When such a transaction must be received to fall into a given cycle, and at what value it is then struck, are both set in regulation, and how that value is computed belongs to the coverage of how pooled vehicles work inside. Both requirements are revised from time to time. The Securities and Exchange Board of India publishes the current text at sebi.gov.in.

One more consequence, settled under price against value. A traded price is what somebody would accept; the value behind the unit is what the underlying holdings are worth per unit. Two quantities, usually close and not the same number, so a traded price can sit either side of the value behind it.

Does a holder's own dealing reach anybody else?

Twenty households put money into one bulk purchase and the grain sits in one shared store. One household wants its money back. Somebody has to sell grain, on whatever day this is, at whatever the buyer will pay. The household that left is gone, and the nineteen that stayed are holding a store that was sold out of at a moment nobody chose.

Transacting with the scheme can force the scheme to buy or sell, and the cost of that trading sits inside the pool and is carried by everybody in it. An exchange transaction between two holders leaves the pool untouched. Hand money to the scheme and it has to put the money to work; take money out and it has to find the money. Either way the pool may trade, and trading is not free.

One shape makes part of the cost of dealing a communal costA cost caused by one holder's decision but carried inside a shared pool, so that every holder in it bears a share. and the other makes it a personal one. The difference is structural, not a criticism of either route. Each is the other's mirror image: on the communal route nobody who wants out hunts for a buyer, and on the personal one a holder at an awkward size must find somebody who will take it.

Is the trading a pool does large enough to notice? The Anantara mandate is one holder's account rather than a pooled scheme, so it is a yardstick for scale and nothing more. The mandate recorded turnover of 34 per cent over the stated twelve month period, so roughly Rs 170 crore of the Rs 500 crore was replaced inside the year. Turnover at that weight carries a cost that no return figure on the record displays.

What does the account need before either route is open?

A route that cannot be reached is not a route. Two shops sell the same thing, and one delivers only to addresses inside a particular pin code. For a household living outside it, arguing about which shop is better avoids the fact that only one shop is available.

Trading a listed unit needs an arrangement with an exchange and a settlement arrangementThe plumbing by which securities and money actually change hands after a trade is agreed, so that both sides end up with what they traded for.. Transacting with a scheme needs an arrangement with the scheme instead. Neither requirement is optional. Without the first, listed units cannot be bought or sold by that account at all.

For an institutional mandate the arrangement is usually in place already. For a small account it may not be. The same comparison then produces two different answers depending on who is asking. The Anantara portfolio has a custodian and a broker in place, so both routes are open. For a household running a small monthly amount, the first thing to establish is not which route is cheaper but which route exists. A delivery route the account cannot use is not an option however good it looks in a table.

What does it cost to arrive and to leave?

Every route has two costs and most comparisons show one. The hire charge for a wedding hall is on the quotation; the cost of getting three hundred guests there and home again is not, and the second cost differs from one hall to the next. The full cost of a delivery route is what the arrangement charges to run plus what it costs to arrive and to leave, and the headline figure normally covers the first part only.

The entry and exit costWhat it costs to get into a holding and out of it again, as distinct from what it costs to keep holding it year after year. on the listed route has three components. Trading a listed unit costs whatever the broker charges, plus the quote gapThe difference between the price somebody is willing to buy at and the price somebody is willing to sell at, which a transaction has to cross. that any transaction has to cross, plus the market impactThe movement in price a large order causes by its own weight, because filling it uses up whatever the other side was offering. that a large order causes by its own weight. The second is paid without a bill, because the purchase happens at one side of the gap and the sale at the other. The third grows with the size of the order against what the other side is offering. A large account and a household therefore face different versions of it.

Transacting with a scheme has its own shape. The route may carry an adjustment applied on entry or on exit, and what may be charged there is set in regulation. Those limits are revised, and the Securities and Exchange Board of India publishes the current text at sebi.gov.in. The two costs are not even the same kind of object. On one route the cost is assembled from three components that can be named. On the other it arrives as a single adjustment whose limits are the regulator's to publish. Pretending those are the same kind of object is how a tidy table becomes a false one.

No rate for any of these costs on either route sits in the available record. A reader who wants a number has to get it from the arrangement in front of them and the market being dealt in, on the day. A figure filled in from recollection is a wrong number wearing the clothes of a right one.

What does the comparison look like set out line by line?

Six lines answered for both shapes, and three left blank on purpose. A sheet with no empty cells anywhere is usually one whose author did not know which cells they could not answer.

What does the difference look like on a Rs 300 crore sleeve?

The Anantara equity sleeve is Rs 300 crore, 60.0 per cent of the Rs 500 crore portfolio, and Faiz Ahmad Ansari wants an exposure inside it changed. The same exposure is available on both routes. Nothing about the design is in question. Only the route is.

Take the first route. Transacting with the scheme, the account receives the value struck for that cycle, exactly as every other holder in it does. Size does not buy a better number and arriving early does not either.

Take the second. Trading on the exchange, the account receives whatever the other side would accept. The accepted price can sit above or below what the underlying holdings are worth per unit. A decimal nobody argues about becomes an amount somebody argues about the moment it is multiplied by the position. On Rs 300 crore, 0.10 per cent is 0.001 times Rs 3,00,00,00,000/-, which is Rs 30,00,000/-, or Rs 0.30 crore, and 0.50 per cent is 0.005 times the same base, which is Rs 1,50,00,000/-, or Rs 1.50 crore. Against the Rs 500 crore portfolio those same two amounts read 0.060 per cent and 0.300 per cent instead, so the base belongs in the sentence every time.

On the second question, the cost one holder's dealing puts on everybody else, the account is not choosing between paying and not paying. The choice is between paying alone and paying into a shared arrangement where costs travel both ways.

The mandate's own measured cost of delivery for the stated twelve month period is Rs 9.40 crore, being a management fee of Rs 6.25 crore and a performance fee of Rs 3.15 crore. The two together are 1.88 per cent of the Rs 500 crore portfolio. Those are this invented mandate's own commercial terms, not a market rate or anything a regulator sets. Against it, Rs 1.50 crore is about 16 per cent of the whole year's delivery cost and Rs 0.30 crore about 3 per cent. A single transaction executed 0.50 per cent away from the value behind the unit costs roughly a sixth of what an entire year of running the mandate costs.

Which route is cheaper is not settled here: deciding that needs a rate for the entry and exit cost on each route and a figure for how far a traded price has sat from the value behind it, and the record holds none of the three.

Where does the comparison usually go wrong?

Almost always in the same place, and almost always by somebody careful. A reader lines the two shapes up, finds one headline cost figure for each, sees that one is lower, and treats the matter as settled.

The headline covers what the arrangement charges to run, year after year, and nothing about getting in and getting out. The counterparty question lands on getting in and getting out, so that is exactly where the two routes differ. The one component that is structurally identical in kind across the two shapes got compared, and the one that is structurally different got dropped.

How does a practitioner actually use any of this?

Faiz Ahmad Ansari asks three questions in order, before a single cost figure is opened: whether both routes are open at all, what size the transaction is against what the other side is offering, and whether the account will deal in this holding repeatedly or sit in it. Entry and exit cost is paid per transaction and the cost to run is paid per year, so the third question decides the weight of the other two.

Rukmini Deshpande, chairing the endowment's investment committee, puts one question to the paper in front of her: which components of this cost does it show, and which exist but are not shown? The most useful thing a committee can do with this comparison is refuse a cost line that does not say which parts of the cost it contains.

An analyst reviewing somebody else's reporting uses the incidence question instead. If a pooled arrangement has had large amounts moving in and out, trading was caused inside it and the cost sat with the holders who stayed. Nothing needs to be alleged. A stated result carries the marks of other people's decisions. Those marks are a fact about the shape rather than about the manager.

The mandate's own record shows why the arrival and departure costs deserve this attention. For the stated twelve month period the Anantara portfolio returned 14.2 per cent against a benchmark of 12.6 per cent, a gross excess of plus 1.6 percentage points, and the measured delivery cost of 1.88 per cent turned that into a net 12.32 per cent, a shortfall of 0.28 percentage points net of everything charged. A gap that small is settled by cost components of exactly this size. What the record cannot settle is what any alternative would have returned or cost, because it holds no alternative.

When does the distinction stop mattering?

Four conditions make the choice between these two shapes change nothing for the holder, and saying so plainly is more useful than hedging. Where the ability to deal during the day is never exercised, where two arrangements follow the same list closely enough that the difference in what they deliver is smaller than the cost gap between them, where the holding is small enough that one broker charge and one crossing of the quote gap outweigh a whole year of the difference in what the two charge to run, or where the account has no exchange arrangement at all, the route decides nothing and the design decides everything.

The mandate's own figures size the first condition. A price difference of 0.50 per cent on the Rs 300 crore sleeve is Rs 1.50 crore, about 16 per cent of the Rs 9.40 crore measured for one year. Set the same one-off amount against ten years of that measured cost, Rs 94.00 crore, and it is about 1.6 per cent. Arrival cost is paid once and running cost is paid every year, so the longer the holding is held the less the arrival cost decides. A holder who buys once and never deals again has paid for a tradability they will not use.

The second condition is about the two arrangements rather than the account. Where both follow the same list and the difference in what they deliver is smaller than the cost gap between them, the route settled nothing the design had not already settled. Where both follow a published index the comparison narrows further and is taken up separately, as is the wider set of delivery routes beyond these two. The third condition runs in the opposite direction on the same arithmetic as the first: at a small enough holding the amounts paid once swamp the yearly difference, so the account that deals rarely and the account that deals in small size arrive at the same place by opposite routes. The fourth is not a preference at all. An account with no exchange arrangement and no way to settle has one route, so the comparison never arises. The rates, charges and limits that bear on all of this are set in regulation and are revised.

Every one of the four conditions expires without announcing itself. The holder who was never going to deal finds a reason to. The holding grows. The two arrangements drift apart. The account opens the exchange arrangement it did not have. Nothing marks the day the comparison becomes live again. Understanding it before it is needed beats meeting it on the day.

The Anantara Multi-Asset Portfolio, the charitable endowment that holds it, Rukmini Deshpande and Faiz Ahmad Ansari are invented.
Educational material. Not advice on any investment, tax, budget or market position.