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Berko: Mutual vs. exchange-traded funds

By Malcolm Berko

Published: August 18, 2018, 6:05am

Dear Mr. Berko: What’s the difference between exchange-traded funds and mutual funds? I just read your column on convertible bonds and noticed that you only recommended ETFs and didn’t write about mutual funds. I bought $10,000 worth of Franklin Convertible Securities Fund in 2007, and it’s worth about $17,000 today. I’d appreciate it if you could recommend several other convertible bond mutual funds like that one.

— VF, Kankakee, Ill.

Dear VF: There are some important differences between an exchange-traded fund and a mutual fund that are worth a tinker’s dam, and they are:

1. ETFs are bought and sold just like common stock, through a broker employed by a brokerage house. ETFs trade just like common stocks, such as Verizon, PepsiCo and Microsoft. As with common stocks, ETF prices can change from second to second. With MFs, though a purchase can be made whenever the stock market is open, the actual purchase/pricing is not concluded until after the market closes.

2. ETFs tend to focus their portfolios on specific market indexes, such as utilities, banks, artificial intelligence, biologics, home construction, gold, real estate, telecommunications, the S&P 500, the Russell 2000, the Dow Jones industrial average, etc. Most ETFs invest passively and tend to do little trading in securities. MFs, however, are actively traded and may rotate their portfolios by 25 to 90 percent during the year.

3. When you purchase an ETF, you pay a commission, just as you do when purchasing a common stock. A 1,000-share purchase of an ETF at J.P. Morgan might cost $300, whereas that same purchase at a discount brokerage, such as Charles Schwab, would cost you $4.95. ETFs usually end up costing you much less than MFs because there’s never a load with an ETF as there are with MFs. With MFs, entrance and exit fees are sometimes exorbitant. And because of low portfolio turnover and the manner in which they are structured, ETF investment gains are taxed more favorably than gains on MFs.

4. Most importantly, the annual management fees for MFs are often three to four times those of ETFs. As you’ll see later, that makes a significant difference.

There are other differences, but in my opinion, they’re insignificant. Meanwhile, I like your Franklin Convertible Securities Fund (FISCX-$21.50), which has enjoyed three-, five- and 10-year average annual total returns of 10.7 percent, 10.6 percent and 8.9 percent, respectively. But it has a 5.75 percent sales commission plus a 0.8 percent expense ratio.

Check out the Calamos Convertible Fund (CCVIX-$18.80), which has a $600 million portfolio that includes Tesla, Wells Fargo, NextEra Energy and Workday. It has a Morningstar rating of three stars, a price-earnings ratio of 12.5-to-1, a price-to-book ratio of 3.5-to-1 and a price-sales ratio of 0.49-to-1. The three-, five- and 10-year average annual total returns are 6.3 percent, 7.3 percent and 6.2 percent, respectively. CCVIX has a 1.2 percent expense ratio every year.

Look at the Putnam Convertible Securities Fund (PRCCX-$26.18), which has a $731 million portfolio and owns issues such as Micron Technology, ON Semiconductor, Jazz Pharmaceuticals and Crown Castle. This fund has three-, five- and 10-year AATRs of 5.2 percent, 7.1 percent and 6.2 percent. It is rated three stars by Morningstar, has a P/E of 20.1-to-1, has a P/B of 2.1-to-1 and has a P/S of 2.3-to-1. Its annual expense ratio is 1.95 percent every year.

The MainStay MacKay Convertible Fund (MCCVX-$17.81) owns a $1.2 billion portfolio that includes Anthem, Danaher, Air Lease and Microchip Technology. MCCVX’s AATRs for three, five and 10 years are 6.3 percent, 8.4 percent and 6.6 percent. It has a P/E of 17.1, a P/B of 2.4 and a P/S of 1.4. Its expense ratio is 1.89 percent this year.

It seems that almost all mutual funds specializing in convertible securities have lower returns than the S&P 500, which enjoys a 10-year AATR of 9.5 percent. However, the average ETF that owns a passive portfolio of convertibles has a low expense ratio of less than 0.5 percent and a 10-year AATR of 8.8 percent. And in 10 years, a low expense ratio can make a huge difference to your ETF or MF.

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