What's the difference between a mutual fund, an ETF and an Investment Trust?

Funds, ETFs, investment trusts - they all do the same basic job of pooling your money with other investors’, so you're not putting all your eggs in one basket. But how you buy them, how they're priced, and how much say you get over what happens to your money varies a lot between the three. Here's Boring Money's plain-English breakdown of what actually separates a mutual fund from an ETF from an investment trust, and which one might suit you.

1. What is a mutual fund?(OEIC or UCITS fund)

Mutual funds pool together investors’ money, which is then managed on their behalf by a dedicated investment manager. They will use their skill and experience to choose companies with a strong pathway of growth and/or income, depending on the investment goals set out for the fund. Most mutual funds will have a specific area of focus – say, European stock markets, or the technology sector.

These funds are ‘open-ended’, which means that new units are created when money comes into the fund, and retired when an investor exits. The fund manager will need to buy new investments as new money comes in, and sell investments to meet redemptions. The net asset value of the fund will match exactly the value of the underlying holdings. Mutual funds usually price once a day.

Investors can monitor the performance of their holdings through groups such as Morningstar or Trustnet. Performance is usually judged against their peer group – for a European fund that might be the Investment Association’s Europe ex UK sector, for example – or against a benchmark, so a UK fund might be measured against the FTSE All Share.

2. What is an ETF (Exchange-Traded Fund)

ETFs have some similarities with mutual funds, in that they aim to give cheap, diversified The process of spreading your investment portfolio across different asset classes, such as partially in shares and partially in bonds, in order to reduce risk.access to stock markets and other securities markets. However, unlike mutual funds, ETFs are traded on an exchange and the price fluctuates according to demand. An ETF can trade at a premium or a discount to the value of the underlying assets (though with large, liquid ETFs, this is rare).

ETFs can be structured to track everything from commodity prices, to major indices, to baskets of stocks. The most popular ETFs track major indices such as the S&P 500An index that tracks the performance of the 500 largest publicly traded companies in the United States. It's often used as a benchmark for the overall global stock market. or the MSCI WorldA global index that tracks large and medium-sized companies from 23 developed countries around the world.. The iShares Core S&P 500 UCITS ETF, one of the largest UCITS-domiciled ETFs available to UK investors [1].

ETFs have multiple options. When investing in stock markets or commodities, for example, they will use ‘physical’ or ‘synthetic’ replication. Physical replication requires buying a small share of each of the underlying securities. ‘Synthetic’ replication aims to create the index or commodity return using derivatives, such as futures.

There are also ETFs on currencies, including more esoteric areas such as Bitcoin and Ethereum. It is also possible to buy leveraged ETFs that offer 2x or 3x exposure to a particular security. There are also inverse ETFs, which use derivatives to go short a stock and – potentially – profit from its decline.

ETFs are usually cheap and liquid. They offer an easy way to get access to a diversified portfolio of companies and investors can buy them easily through a platform or a broker. However, while most people will use them to track a stock market index, they can have a far broader range of uses in a portfolio.

3. What is an Investment Trust?

Investment trusts (or investment companies) are one of the oldest types of collective fund. They are listed companies that invest in shares, bonds, and other assets, such as property. Most commonly, they will invest in a portfolio of shares, but there are also Investment Trusts that invest in areas as diverse as care homes, wind farms, or aircraft leasing. The choice is vast.

Investment Trusts have a board of directors that look after the interests of shareholders. They will ensure the investment manager is staying on track and will take steps to switch if they are not. The board is also responsible for reporting back to shareholders on the trust’s performance.

Investment Trusts are ‘closed-ended’, which means that the fund manager doesn’t have to buy and sell assets when investors buy in or sell out of the fund. This gives Investment Trusts some advantages when managing less liquid assets such as commercial property or infrastructure. Investment trusts can also be useful for income-seekers: they have the ability to reserve income in buoyant times to pay it out in tougher times, helping smooth the return to investors.

The price for an investment trust is determined by the market, so it may trade at a discount or a premium to the value of its underlying holdings. This can give investors an opportunity to buy assets at less than they are worth.

There are good and bad options within all of these fund types and investors can construct a diversified portfolio using just one option, or a blend of all of them. There is abundant choice for all types of investor.

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[1] JustETF