ETF Does Not Mean Index

A big misnomer with investing has been the view that “ETF” means indexing. “ETF” stands for “Exchange-Traded Fund”. An ETF is just a structure. It just so happens that the main use of ETFs have been to serve as a vehicle for indexing strategies. But if you break down the words, you’ll notice that it is just an investment fund that trades on an exchange. It is possible for an ETF to be actively managed. It is possible for an ETF to have high fees. It is also possible for ETFs to be less than tax efficient. In fact, it is also possible for an ETF to be poorly diversified.

Similarly with mutual funds – a mutual fund does not mean active management.  There are plenty of index funds structured as mutual funds, although the majority are actively managed portfolios. It is possible for mutual funds to have low turnover, tax efficiency and broad diversification. A mutual fund is just a structure.

In fact, if you look at any iShare prospectus, you’ll see that their ETFs themselves are in fact, mutual funds. Look on page 61 of the most recent prospectus, under the overview of the legal structure. (Note: you may have to indicate your status as an individual investor, financial advisor, or institutional investor first on an splash page – once you’ve done that you can re-click the link above to go straight to the prospectus.)

Imprecision irks me, and it certainly clouds the issues for everyone when anyone discussing active/passive or ETFs/Mutual Funds uses sloppy terminology. That’s my rant for the week. :)

Preet Banerjee
Preet Banerjee an independent consultant to the financial services industry and a personal finance commentator. You can learn more about Preet at his personal website and you can click here to follow him on Twitter.
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Showing 7 comments
  • Michael James

    Equating ETFs with indexes is probably a little more advanced than trying to decide whether to “buy an RRSP”. A person who thinks RRSPs are all the same creates an opportunity for a high-fee mutual fund seller, and a person who thinks ETF means low-cost index creates an opportunity to create ETFs with big fees. A big part of the success of many businesses is based on public ignorance. Can I help you contact a deceased loved one?

  • Mr. Cheap

    Interesting rant. I’m pretty sure I’ve used “ETF” to mean indexing in the past, and you’re absolutely right that I shouldn’t.

    I henceforth resolve to do so no more! :-)

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