DIFFERENT TYPES OF ETFS

There are literally thousands of funds available around the world. All offering different stocks, assets, markets and investment strategies. So, let’s look at the different ETFs you can choose from.

What you will discover?

  • Why there are so many ETFs
  • The types of ETF on offer today
  • Which ETFs might suit you

Why are there so many ETFs?

Two things have driven the growth in the number of ETFs to around 8,800 globally1:

  1. investor demand;
  2. improvements in technology which has helped make ETFs low cost and easy to trade.

As an investor you may want to invest in different markets, sectors or asset types. Want an ETF that covers the whole Hang Seng Index? Or perhaps you just want tech stocks or UK stocks. No problem, there’s an ETF just for that.

Common types of ETFs available today

The majority of ETFs are index-based and aim to replicate a specific index or benchmark. These indexes could be based on stocks like the Hang Seng or a bond index. Whatever the underlying asset, an index ETF aims to track index performance by holding all or a representative sample of the index.

For example, Hong Kong’s Hang Seng Index tracks the top 50 companies by size listed on the Hong Kong Stock Exchange. An ETF that tracks the Hang Seng will typically hold all 50 stocks in the same proportion as the Index.

Equity ETFs

Equity ETFs track an index of equities. You can choose ETFs covering large businesses, small businesses, or stocks from a specific country. Equity ETFs also let you target sectors that might be doing well at that time, like tech stocks or banking stocks, which makes them a popular choice.

Bond/Fixed Income ETFs

It’s important to diversify your portfolio2. Spreading your investment risk is just good practice. That’s why most professionals will also invest in fixed-income and bond ETFs that provide steady return at potentially lower risk than equity ETFs.

Commodity ETFs3

Often harder to access than stocks, ETFs are a great way to get into commodities like gold, silver or oil. These are an attractive alternative to stocks to further diversify your portfolio and risk. However, commodity ETFs can be less transparent than index or stock ETFs. They often don’t directly own the underlying asset, like gold, but use derivatives4 instead. Derivatives track the underlying price of the commodity but can carry more risk, such as counterparty risk5, than an ETF which owns the underlying asset directly.

Currency ETFs

Currency ETFs will invest in either a single currency, like the US dollar, or a basket of currencies. The ETF will either invest in the currency directly, use derivatives or a mix of the two. Using derivatives can potentially add more risk to the ETF, so you need to be sure what you’re buying. You’d buy a currency ETF if you thought the underlying currency is likely to strengthen or if you wanted to protect or hedge6 your investment portfolio. Some ETFs that invest in overseas markets may already ‘hedge’ against currency risk7.

Specialty ETFs

Two fund types that have emerged in recent times to meet very specific needs are leveraged funds and inverse funds8. These specialty ETFs offer much greater growth potential but also a much higher risk.

  • Inverse funds go up when the target index goes down – similar to investors short-selling a stock as its price falls
  • Leveraged funds aim to maximize returns by borrowing more money (leverage) to invest. You’ll recognize these ETFs as they typically say by how much they are leveraged, for example, 2X will borrow an extra $1 for every $1 investors put into the fund.

As well as offering potentially high returns, both of these ETF types can be high risk, so do your homework and know what you’re buying.

Factor ETFs

Factor investing is an investment approach that involves targeting specific drivers of return across asset classes. Institutional investors and active managers have been using factors to manage portfolios for decades. A common way to access factors is through rules-based ETFs. often referred to as “Smart Beta”.

Sustainable ETFs

The range of sustainable ETFs available is growing rapidly. Sustainable investing combines traditional investment approaches with environmental, social and governance insights. Sustainable investing is growing across a wide range of investors. The demand is being driven by trends in demographic shifts, government policies and evolving views on risk.

Which type should I go for?

Which ETF to invest in all depends on you. Think back to your investment goals and what level of risk you are prepared to take to get the returns you want. As with any investment, you need to understand the risk-return ratio of every ETF, which is available in the fund offering documents, or you may speak to a financial advisor who can help you to analyze which ETF can cater to your investment needs. Read more about Risks of ETFs

Key points to take away

  1. ETFs come in many types, each with the objective to give you access to different assets and markets
  2. The range of ETFs ensures that there will typically be an ETF to match your reward and risk profile
  3. You can consider more than one ETF for your goal - some that may offer steady returns with lower risk balanced with ETFs that offer more return potential but with more risk.

ETF SELECTION AND USAGE

What are ETF structures?

There are two types of ETFs: physical and synthetic. We will explore the differences and compare the advantages of both.