Exchange-Traded Fund(ETF)
An exchange-traded fund (ETF) is a type of pooled investment security that can be bought and sold much like an individual stock. The main difference between an ETF and a mutual fund is that though a mutual fund is also a pooled investment, it trades only once a day after market close. An ETF can be structured to track anything from the price of an individual commodity to a large and diverse collection of securities. ETFs can even be designed to track specific investment strategies.
TYPES OF ETF
Various types of ETFs are available to investors that can be used for income generation, speculation, and price increases, and to hedge or partly offset risk in an investor’s portfolio. Here is a brief description of some of the ETFs available on the market today.
Passive and Active ETFs
ETFs are generally characterized as either passive or actively managed.
Passive ETFs aim to replicate the performance of a broader index—either a diversified index such as the S&P 500 or a more specific targeted sector or trend. An example of the latter category is gold mining stocks: as of January 2024, there are approximately nine ETFs that focus on companies engaged in gold mining, excluding inverse, leveraged, and funds with low assets under management (AUM).
Actively managed ETFs typically do not target an index of securities, but rather have portfolio managers making decisions about which securities to include in the portfolio. These funds have benefits over passive ETFs but tend to be more expensive to investors. Actively managed ETFs are explored more below.
Bond ETFs
Bond ETFs are used to provide regular income to investors. Their income distribution depends on the performance of underlying bonds. They might include government, corporate, and state and local bonds, usually called municipal bonds (or munis). Unlike their underlying instruments, bond ETFs do not have a maturity date. They generally trade at a premium (higher) or discount (lower) from the actual bond price.
Additionally, ETFs tend to be more cost-effective and more liquid compared to mutual funds.
Stock ETFs
Stock (equity) ETFs are composed of a basket of stocks that track a single industry or sector. For example, a stock ETF might track automotive or foreign stocks. The aim is to provide diversified exposure to a single industry, one that includes high performers and new entrants with growth potential. Unlike stock mutual funds, stock ETFs have lower fees and do not involve actual ownership of securities.
Industry/Sector ETFs
Industry or sector ETFs are funds that focus on a specific sector or industry. For example, an energy sector ETF will include companies operating in that sector. The idea behind industry ETFs is to gain exposure to that industry by tracking the performance of companies operating in that sector.
Commodity ETFs
As their name indicates, commodity ETFs invest in commodities, including crude oil or gold. Commodity ETFs can diversify a portfolio, making it easier to hedge market downturns. For example, commodity ETFs can provide a cushion during a slump in the stock market.
Holding shares in a commodity ETF is cheaper than physical possession of the commodity. This is because the former does not involve taking possession of commodities, insurance, and storage costs.
Currency ETFs
Currency ETFs are pooled investment vehicles that track the performance of currency pairs consisting of domestic and foreign currencies. Currency ETFs serve multiple purposes. They can be used to speculate on the prices of currencies based on political and economic developments in a country. They are also used to diversify a portfolio or as a hedge against volatility in forex markets by importers and exporters. Some of them are also used to hedge against the threat of inflation.
Bitcoin ETFs
Bitcoin ETFs come in two different forms as of January 2024. The spot bitcoin ETF is relatively new, having been approved by the SEC that month. These ETFs expose investors to bitcoin's price moves in their regular brokerage accounts by purchasing and holding bitcoins as the underlying asset and allowing them to buy shares of the fund.
Bitcoin futures ETFs, approved in 2021, also expose investors to crypto without needing to own the coins. They use futures contracts traded on the Chicago Mercantile Exchange and mimic the price movements of bitcoin futures contracts.
The SEC remains skeptical about the risk associated with crypto, but these ETFs bring some regulatory safeguards and make it much easier to take part in the crypto market.
Inverse ETFs
Inverse ETFs attempt to earn gains from stock declines by shorting stocks. Shorting is borrowing a stock, selling it while expecting a decline in value, and (hopefully) repurchasing it at a lower price. An inverse ETF uses derivatives to short a stock. Essentially, they are bets that the market will decline.
When the market declines, an inverse ETF increases by a proportionate amount. Investors should be aware that many inverse ETFs are exchange-traded notes (ETNs) and not true ETFs. An ETN is a bond that trades like a stock and is backed by an issuer such as a bank. Be sure to check with your broker to determine if an ETN is a good fit for your portfolio.
Stock ETFs
Stock (equity) ETFs are composed of a basket of stocks that track a single industry or sector. For example, a stock ETF might track automotive or foreign stocks. The aim is to provide diversified exposure to a single industry, one that includes high performers and new entrants with growth potential. Unlike stock mutual funds, stock ETFs have lower fees and do not involve actual ownership of securities.
