What Is an Exchange-Traded Fund (ETF)?
An exchange-traded fund (ETF) refers to a type of pooled investment security that works like a mutual fund. Generally, ETFs are designed to track a certain index, sector, commodity, or other assets, but contrary to mutual funds, you can buy or sell ETFs on a stock exchange just like any other regular stock. An ETF could be created in a way that it can be used to keep track of anything right from an individual commodity’s price to a big and diverse collection of securities. ETFs could also be structured to monitor particular investment strategies. Visit MultiBank Group
Understanding Exchange-Traded Funds (ETFs)
An ETF is called an exchange-traded fund because it’s traded on an exchange just like stocks are. The price of an ETF’s shares will change throughout the trading day as the shares are bought and sold on the market. This is unlike mutual funds, which are not traded on an exchange, and which trade only once per day after the markets close. Additionally, ETFs tend to be more cost-effective and more liquid compared to mutual funds.
An ETF refers to the kind of fund which includes several underlying assets, instead of only one like a stock. Given that there are several assets in an ETF, they could be a preferred choice to diversify one’s portfolio. ETFs could work with multiple investments, including stocks, commodities, bonds, or a mixture of investment types.
Types of ETFs
Different types of ETFs which investors could access could have several uses such as income generation, speculation, and price increases, as well as to hedge or offset parts of the risk in an investor’s portfolio. Below are some ETFs in the market:
Passive and Active ETFs
ETFs can be typically categorized as passive or actively managed. Passive ETFs are expected to mimic how a broad index performs—it could either be a diversified index like the S&P 500 or a much more particular targeted sector or trend. Gold mining stocks are good examples of a targeted sector: as of February 18, 2022, there are roughly eight ETFs that lay emphasis on companies that work in gold mining, besides the inverse, leveraged, and funds with low assets under management (AUM).
Actively managed ETFs generally are not aimed at an index of securities. Instead, portfolio managers make the decisions with respect to the securities that have to be a part of the portfolio. These are often funds that tend to perform better than passive ETFs but are typically pricey.
Bond ETFs can be used by investors to have a source of regular income. The income distribution happens on the basis of how underlying bonds perform. They could be inclusive of government bonds, corporate bonds, and state and local bonds—known as municipal bonds. Contrary to their underlying instruments, bond ETFs do not come with a maturity date. They typically trade at a premium or discount that makes it lower than the original bond price.
Stock (equity) ETFs include a basket of stocks which tracks only one industry or sector. For instance, a stock ETF could track automotive or foreign stocks. The goal is to offer diversified exposure to an industry which takes into account high performers as well as new players who have growth potential. Contrary to stock mutual funds, stock ETFs tend to have much lower fees and do not require the investor to take ownership of securities.
Industry or sector ETFs refer to funds that concentrate on a certain sector or industry. For instance, an energy sector ETF would take into account the different companies which work in that sector. Industry ETFs are aimed at gaining exposure to the positive side of the industry by keeping a track of how the companies in the specific sector are performing.
An instance would be the technology sector, which has been taken over by a huge number of funds in recent years. At the same time, the difficult part of a stock’s volatile performance is brought down in an ETF since they don’t include direct ownership of securities. Industry ETFs also help for in and out rotation between different sectors during economic cycles.
Similar to what the name indicates, commodity ETFs invest in commodities, such as crude oil or gold. Commodity ETFs have many advantages, the first one being the fact that they act as a hedge and also diversify a portfolio.
For instance, commodity ETFs could offer a cushion when the stock market takes a hit. Second, it is much more cost-effective to have shares in a commodity ETF than physical possession of the commodity. This is the case since there are no insurance and storage costs involved in the former.
Currency ETFs refer to pooled investment vehicles which are able to assess the performance of currency pairs that include domestic and foreign currencies. Currency ETFs have many purposes. They could be used to predict currency prices on the basis of political and economic developments in a country. They could even be used to hedge against volatile forex markets.
Inverse ETFs try to earn from the fall in stock values by shorting stocks. Shorting refers to selling a stock, hoping that its price would decline further, and then buying it again at a lower rate. An inverse ETF employs derivatives to short a stock. It’s essentially placing a bet on the market’s decline.
If the market falls, an inverse ETF’s value increases by a proportionate amount. Investors need to know that several ETFs are exchange-traded notes (ETNs) and not exactly ETFs. An ETN refers to a bond which can be traded like a stock while being supported by an issuer like a bank.
A leveraged ETF attempts to return some multiples (e.g., 2× or 3×) when the underlying investments bring a return. For example, should the S&P 500 increase by 1%, a 2× leveraged S&P 500 ETF will be able to return 2% (and in case the index falls by 1%, the ETF would have to shed away 2%). These products use derivatives like options or futures contracts to boost their returns.