Both unit trusts and exchange-traded funds (ETFs) offer you an opportunity to earn a return through a diversified pool of securities. In short, you can invest in a lot of companies with a little bit of money with either one. Of course, as you probably gathered from the fact that they have different names, ETFs and unit trusts are different types of structures that behave in different ways and carry different tax consequences. A unit trust is a fund that typically holds specific assets in specific quantities and passes profits and income to its investors. Essentially, investors are beneficiaries under the trust. An ETF is a security that tracks an index (such as the S&P 500) but trades like a stock on an exchange.
Unit Trust
A unit trust buys securities in a portfolio, which it sells to investors as shares in the trust. The unit trust passes along capital gains, interest income and dividends directly to shareholders. A unit trust sounds like a mutual fund, but it's not. Unlike a mutual fund, a unit trust doesn't actively participate in buying and selling securities to include in the portfolio, which means it has lower annual operating expenses than a mutual fund. Instead, it buys a set basket of securities, and its investors share in the profits, income and losses. You can invest in a unit trust directly through a unit trust management company or indirectly through a broker or financial adviser.
ETF
An ETF is a security that trades on an exchange, like a stock. An ETF tracks an index fund, commodity or a group of stocks. So rather than a set basket of investments, like a unit trust, an ETF typically holds a dynamically changing bag of investments. There are many ETFs to choose from depending on your investment objective. The main benefit of investing in an ETF is that it gives you a chance to invest in a basket of securities for a fraction of the cost. For example, the PowerShares Dynamic Industry ETF gives you an opportunity to invest in a basket of companies within the same industry (such as pharmaceuticals). One of the most popular groups of ETFs is the Standard & Poor's Depositary Receipts, or SPDR ETFs. Examples within this group are the SPDR S&P 500 Index, the SPDR Dow Jones Industrial Average ETF, SPDR Gold Shares and SPDR Barclays Capital High Yield Bond EFT.
Net Asset Value
One value you'll see quoted often when it comes to an ETF or unit trust is net asset value (NAV). To calculate NAV, investors take the total value of the fund's assets minus its liabilities and divide the result by the number of shares in the hands of shareholders. For example, if the total value of the fund is $95 million and shareholders own 10 million shares, the fund's NAV is $9.50 per share. If the fund increases in value to $100 million and the number of shares stays the same, the NAV increases to $10.
Things to Consider
You should weigh the risks and reward benefit as well as the cost of investing in either an ETF or unit trust. An ETF allows you to trade it like a stock with low transaction costs. In contrast, many unit trusts have sales fees and entrance and exit fees. The upfront cost to invest in a unit trust may be as low as 0.5 percent to as high as 6 percent. There is also typically an annual fee varying from 0.75 percent to 2 percent. There's no active management of a unit trust, which means securities aren't bought or sold to take advantage of market conditions or opportunities. Both ETFs and unit trusts carry risks. You can, however, use a hedging strategy, and invest in a "reverse ETF," designed to go up if a certain index goes down, which can reduce risk if combined with regular ETFs (of course, this risk reduction is not guaranteed).
Taxation
If you own a unit trust, you are taxed on its securities' activities as though you owned them directly. For example, you may pay income taxes on any dividends that are distributed to the trust's securities but, since the trust doesn't actively trade its stocks or bonds, you won't face capital gains or losses until you sell your shares. This gives unit trust owners a great degree of control over their tax situations, much like the direct owners of stock. ETFs are taxed more like mutual funds. For example, a typical ETF will trade many securities through the course of the year, and the owner of an ETF share will experience taxable gains or losses on those trades, even if they don't sell their shares during the year.
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