When doing your research on ETFs, read the prospectus and the information available on the issuer's website. There are many different types of ETFs, depending on what the fund tracks but also the weighting of the securities, whether or not there is additional risk exposure, etc. Make sure you understand what exactly you are buying before you invest.
Types of ETFs
The most common type of ETF, an index ETF, tracks a specific U.S. or foreign stock index (e.g. NASDAQ 100, FTSE 100, S&P 500, Russell 2000, etc.). There is a wide variety of index ETFs that investors can choose from.
ETF sector / industry
These ETFs represent a specific sector (industry group), for example. technology, energy, materials, industries, health care, finance, utilities, basic consumer goods, etc. They follow the collective performance of this industry. As with most other types of ETFs, there are ETFs from US, foreign and global sectors.
ETF size specific
These ETFs are defined by the market capitalization of the individual stocks. For example, large-cap companies (typically over $ 10 billion in market capitalization), mid-cap companies ($ 2 billion to $ 10 billion), small caps ($ 300 to $ 2 billion), micro- capitalizations (50 to 300 million dollars).
Country specific ETF
These ETFs track the performance of the markets of an individual country or, in some cases, an entire region (e.g. Eastern Europe, Eurozone, Latin America, Asia, etc.) . There are many international ETFs listed on the US and foreign stock exchanges.
Commodity ETFs track the performance of a commodity (e.g. Oil, natural gas, gold, silver) or a basket of commodities (such as precious metals, base metals, commodities). agricultural raw materials, etc.).
A Currency ETF provides investors with the ability to track the performance of various currencies across the world, such as US Dollar, Japanese Yen, British Pound, Euro, etc. (It's important to note that while FOREX is essentially a 24-hour market, currency ETFs have the downside that they can only be traded during trading hours.)
Fixed Income ETFs
ETFs that track corporate bond or Treasury bond indices.
ETF by weighting model
Most ETFs (and indices) are weighted according to market capitalization, which means that large companies have a much greater representation in the index and greater influence over price movement. Most of the index's capitalization is concentrated in major stocks.
A few providers now offer equally weighted ETFs (index and sector), which give a broader representation of companies within the index. Each stock is initially given equal weight, which allows you to spread your risk evenly across all stocks in the index. It also means you're more exposed to small and mid-sized companies, which often outperform large caps.
The other problem with the market cap weighting is that stocks that have rapidly risen in price and become overvalued will have a higher weight in the index. (The higher a stock's valuation, the higher its market capitalization.) Equal-weighted ETFs avoid overweighting stocks that trade above their fair value.
To maintain an equal weight, an equal weight ETF needs periodic rebalancing (usually done on a quarterly basis).
This means that these ETFs (compared to traditional index ETFs) generally have higher expense ratios, as well as higher bid-ask spreads (as they tend to be more finely traded). As rebalancing involves the sale of stocks that have appreciated the most, it results in higher transaction costs but also a higher tax liability (due to the realization of capital gains).
While evenly weighted ETFs are a great addition to the ETF universe, they tend to be slightly more expensive and less tax efficient, which can result in a lower compound return. Investors should carefully consider whether these ETFs will benefit their portfolio.
While traditional indices are weighted by market capitalization, fundamentally weighted ETFs offer an alternative to companies weighted by fundamental factors (such as book value, earnings, dividends, etc.).
Some ETFs are weighted to suit a certain style of investing. For example, there is a range of value ETFs that select companies based on price / earnings, price / pound combinations, price / cash flow ratios, dividend yield, etc.
As we've seen with equal weighting, ETFs that are weighted other than by market cap tend to have higher portfolio turnover (since they have to buy and sell securities when prices move). ). This leads to increased transaction costs and reduced tax efficiency; both generally apply to fundamentally weighted ETFs.
Actively managed ETFs
Actively managed ETFs have been around since 2008 and have so far not been popular with investors. These ETFs, instead of following an index, use a manager to select which securities to include in the fund.
Actively managed ETFs have similar problems to traditional actively managed mutual funds … the expense ratio and transaction costs are higher and the tax obligations are higher.
Therefore, the manager must add enough value to compensate for this. Now, as we can see with most mutual funds, this rarely happens. Since most managers don't do better than market averages, the benefits of actively managed ETFs can be questionable (at least until we start to see some track record of these funds).
While ETFs were first introduced as passive, inexpensive and transparent investment vehicles, there are now a number of very complex ETFs as well. Some of these have proven to be quite popular with experienced traders and investors, but it is essential that you fully understand the risks before investing in these more exotic vehicles.