What is a Market ETF?
Market ETFs are single investment products designed to track a particular stock market index with the goal of following (not outperforming) said index. A market ETF consists of the same equities as the index it tracks. It may not contain all the equities in that particular index (although some do), but the construction of the ETF will be similar enough so that it will move in the same direction of its correlating index.
Why Buy (or Sell) a Market ETF?
There are two main reasons to trade a market ETF.
1. Gain exposure to a certain Market
2. Hedge risk to a certain Market
If you would like to invest in a certain exchange index like the US DOW or the German DAX, a market ETF makes it easy to gain exposure to that index with a single transaction. You don’t have to purchase individual equities like you would when trading a mutual fund or the index itself. An ETF is a lot less complex and cost-efficient as well.
The other reason to include a market ETF in your trading strategy is to decrease portfolio risk. If your investment portfolio has upside or downside risk exposure to a certain market, you can buy or sell a market ETF to hedge that risk.
For example, let’s assume your portfolio is heavily invested in Japanese securities. Selling the EWJ (The Japanese Nikkei Index ETF) can help decrease some of that exposure. The goal here would be to soften the blow if your Japanese investments go sour due to international factors. You would most likely win on your short EWJ transaction to offset some losses.
As a side note, an international market index ETF like EWJ can be considered foreign ETFs as well.
What are the Features of a Market ETF?
Besides the many advantages ETFs have in general over other investment products like mutual funds and indexes, market ETFs have a few added benefits.
Market ETFs tend to be less volatile than industry ETFs and other funds due to their diverse construction. The securities in a market ETF run across all industries, so there is less risk of all sectors moving in the same direction at the same time. In turn that keeps the movements of a market ETF more controlled. However, certain economic climates like recessions and booms can pull a market ETF in a certain direction quite quickly depending on the severity of the situation.
Due to the decreased volatility of a market ETF, the bid-ask spreads tend to be tighter. Traders have a little more confidence making a market since they don’t have a lot of risk that the market will violently change…barring any unforeseen industry. For that reason, a market ETF investor may have an easier time fulfilling a buy or sell order than with other ETFs.
I am ready to look into Market ETFs. What are some of the Funds I should follow?
If you think market ETFs should be part of your investment stratagem, I suggest tracking some of the major funds so you can get a feel for how they behave. As with any investment product, it is very important to conduct in-depth research before you get started with ETFs. Here are some market ETFs that track major indexes. Look before you leap, and good luck.