ETFs and index funds share the same objective. They both want to replicate an index as accurately as possible. However, they differ in the form and manner in which they are offered. While ETFs, as the name “Exchange Traded Funds” suggests, are traded on the stock exchange, index funds are not exchange-listed. Index funds can only be obtained from the issuer, which is a restriction but also has advantages. For example, domestic index funds are not subject to stamp duty. Furthermore, thanks to the investor group control, index funds can reclaim withholding taxes on dividend and interest income to a greater extent than ETFs. It is worthwhile to avoid withholding taxes when investing in pension assets.
| ETF | Index fund | |
| Goal | Replicating an index as accurately as possible | Replicating an index as accurately as possible |
| Listed on stock exchange | Yes | No |
| Price setting | Continuously during trading hours | daily (NAV) |
| Liquidity | depending on size of ETF or trading volume | Unlimited liquidity (theoretical) |
| Transaction execution | During trading hours | Once a day, settlement after close of trading |
| Transaction costs | Brokerage fee, bid-ask spread | Subscription and redemption spread |
| Stamp duty | 0.075 % for domestic ETFs 0.15 % for foreign ETFs | No stamp duty for domestic funds 0.15 % subscribing to foreign funds |
| Counterparty risk | For synthetic implementation and securities lending | For securities lending |
| Withholding tax | Limited recoverability | Largely possible for pension funds with investor group control |
Which fund type to be preferred?
Index funds are preferred over ETFs when long-term and tax-optimised investments are required (pension schemes). ETFs are suitable for short-term trading, as they are listed on the stock exchange and can, therefore, exploit short-term price fluctuations. Does this raise the question as to what extent it makes sense to buy a passive fund product in order to engage in active trading? As studies show, active management does not add value in the long term. What remains are higher costs caused by transaction fees (brokerage, stamp duties, etc.). Particularly when ETFs are held as pension assets, the question arises as to whether index funds would not be more suitable. In contrast to ETFs, they can reclaim withholding tax on foreign dividend and interest income thanks to investor control.
Advantages ETFs:
- Active trading possible through listing on an exchange.
- Larger offer / greater variety of fund products.
Advantages Index funds:
- No brokerage fees.
- No stamp duties on domestic index funds.
- With investor group control (pension funds), withholding taxes on dividend and interest income can be reclaimed.
- Theoretically unlimited liquidity.
ETFs and index funds belong to passive funds
Both ETFs and index funds are passive funds. They do not attempt to be any better than the market. Their sole aim is to replicate the market as accurately as possible. Take the Swiss Market Index (SMI) as an example: An ETF or index fund on the SMI buys shares from any company represented on the SMI. The fund buys more shares from companies that are more heavily weighted in the SMI and fewer shares from companies with a low index weight. In other words, the fund replicates the weighting of the company in the SMI in the fund in order to keep the deviation between the fund and index performance (tracking error) as low as possible.