Exchange-traded funds (ETFs) are investment vehicles consisting of a diverse range of securities, such as bonds, shares, money market instruments, and more. They typically aim to mirror the performance of an underlying asset. In simple terms, ETFs combine different investment options, embodying the favourable aspects of both mutual funds and stocks.
ETFs share similarities with mutual funds in terms of their structure, regulation, and management. Similar to mutual funds, they are collective investment tools that enable investors to access a broad range of asset classes, including stocks, commodities, bonds, currencies, options, or a combination thereof. Furthermore, ETFs can be bought and sold on stock exchanges, just like stocks.
In this post, you can learn about the different types of Exchange-traded funds and what you must consider when investing in an ETF.
6 Different Types of Exchange-Traded Funds
There is a wide array of ETF options catering to the needs of nearly every investor. Here are a few examples of the types of ETFs accessible to individuals:
These ETFs are specifically designed to offer exposure to various categories of bonds. Investing in bonds is an effective strategy for managing investment volatility and achieving portfolio diversification.
These securities enable investors to engage in currency market transactions without the need to directly acquire a specific currency. Such investments aim to track and capitalise on the price movements of any particular currency or a group of currencies.
These funds are specifically structured to generate returns that are the opposite of what is provided by the underlying market index. Inverse ETFs are designed so that the prices of their shares move in the opposite direction of the corresponding market index.
The objective of these funds is to minimise the potential risks associated with price fluctuations and maximise returns. They achieve this by investing in a collection of short-term government securities, including money market instruments, with brief maturities. At the same time, these funds strive to maintain high levels of liquidity.
These securities provide investors with the opportunity to hold ownership in the bullion market without the need to physically buy gold. Alternatively, investors can choose to purchase ETFs that specifically focus on a broader range of precious metals.
Index funds aim to replicate the performance of their underlying index. They can be categorised into two types: replication ETFs and representative ETFs. Replication Exchange-traded funds exclusively invest in the securities that make up the index. Conversely, representative ETFs allocate most of their fund assets to representative samples of the index while also investing a portion in other securities like futures, options, etc.
Things to Consider Before Investing in ETFs
ETFs differ from mutual funds in several aspects. While ETFs possess certain features similar to mutual funds, such as the ability to purchase or redeem shares at each trading day’s end at the NAV per share, they also offer intraday trading characteristics of closed-end funds. This means that ETF shares will be traded during the trading day at the market prices.
Unlike mutual funds, ETF shares can only be bought and sold by retail investors through market transactions. In other words, ETFs don’t directly sell the individual shares to and redeem them from the retail investors. In fact, ETF sponsors establish contractual relationships with at least one or more financial institutions referred to as the “Authorised Participants.” These Authorised Participants are commonly large broker-dealers who have the privilege to purchase or redeem shares from ETF directly but in large aggregations known as “Creation Units,”
Other investors can buy and sell the ETF shares in the market transactions at prevailing market prices. The market price of an ETF usually fluctuates throughout the trading day due to various factors, like the underlying asset prices and the ETF’s demand. In contrast, the ETF’s NAV is also calculated by the fund at each business day’s ending and represents the value of the ETF’s assets minus its liabilities.
The wide variety of Exchange-traded funds available ensures an ETF is typically suitable for your specific risk and reward preferences. When working towards your investment goals, you can consider multiple ETF options. Some ETFs may provide steady returns with lower risk, while others may offer higher return potential but come with increased risk. By diversifying your investment across a combination of such ETFs, you can strike a balance between risk and potential returns.