An ETF is an exchange traded fund – a form of investment fund that is bought and sold on stock exchanges. Typically, ETFs usually seek to track the performance of a benchmark index, and hold assets that help them to do just that.

What are the benefits?

Execellent Value: Benefit from lower fees than Active Funds, less transaction fees, and no stamp duty.

Access: ETF's can be traded on an exchange just like stocks.

Diversification: ETFs can contain all types of investments, including stocks, commodities or bonds from all around the world.

More Opportunities: Access markets you couldn’t normally reach, such as whole stock indices, and invest at any time during market hours.

Transparency: See the assets your ETF holds and know exactly how it’s performing at any time.

Effeciency: Track a whole index, sector or emerging market with a single transaction.

The first ETF was the SPDR S&P 500 ETF, which tracks the S&P 500 Index and which remains an actively traded ETF today.

What are the Different Types of ETFs?

Passive vs Active: 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 or a more specific targeted sector or trend.

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. We explore actively managed ETFs below.

Bond ETFs are used to provide regular income to investors. Their income distribution depends on the performance of underlying bonds. They might include government bonds, corporate bonds, and state and local bonds. Unlike their underlying instruments, bond ETFs do not have a maturity date. They generally trade at a premium or discount from the actual bond price.

Stock ETFs comprise a basket of stocks to 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 potential for growth. Unlike stock mutual funds, stock ETFs have lower fees and do not involve actual ownership of securities.

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 the upside of that industry by tracking the performance of companies operating in that sector. One example is the technology sector, which has witnessed an influx of funds in recent years. At the same time, the downside of volatile stock performance is also curtailed in an ETF because they do not involve direct ownership of securities. Industry ETFs are also used to rotate in and out of sectors during economic cycles economic cycles.

Commodity ETFs as the name suggests invest in commodities, including crude oil or gold. Commodity ETFs provide several benefits. First, they diversify a portfolio, making it easier to hedge downturns. For example, commodity ETFs can provide a cushion during a slump in the stock market. Second, holding shares in a commodity ETF is cheaper than physical possession of the commodity. This is because the former does not involve insurance and storage costs.

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 for 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.

Inverse ETFs attempt to earn gains from stock declines by shorting stocks. Shorting is selling a stock, expecting a decline in value, and 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 but 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.

Leveraged ETFs seek to return some multiples on the return of the underlying investments. For instance, if the S&P 500 rises 1%, a 2× leveraged S&P 500 ETF will return 2% (and if the index falls by 1%, the ETF would lose 2%). These products use derivatives such as options or futures contracts to leverage their returns. There are also leveraged inverse ETFs, which seek an inverse multiplied return.