By Mark Kennedy
Market ETFs usually track a major market index and are some of the most active ETFs on an exchange floor, however there are some market ETFs that track low-volume indexes as well. Keep in mind the goal of a market ETF is to emulate an underlying index, not outperform it. An example would be the QQQQ’s which tracks the Nasdaq-100 index.
The U.S. is not the only country to have market index ETFs. There are many foreign ETFs to choose from as well. If you’re an investor looking for international exposure or to hedge foreign investing risk, country or region ETFs may be an option for you. Two examples are EWJ which tracks Japan’s Nikkei Index and EWG which tracks the MSCI Germany Index.
Speaking of foreign ETFs, foreign currency ETFs help investors gain exposure to foreign currencies without having to complete complex transactions. Currency ETFs are seemingly simple investment vehicles that track a foreign currency, similar to how a market ETF tracks its underlying index. In some cases this type of ETF tracks a basket of currencies, allowing an investor access to more than one foreign currency.
Industry ETFs are types of ETFs that generally track a sector index representing a certain industry. Perfect for gaining exposure to a certain market sector like pharmaceuticals without having to purchase the plethora of individual companies. Instead, with one transaction, you can buy a fund like the PowerShares Dynamic Pharmaceuticals ETF (PJP) and instantly implement your ETF investing strategy.
Commodity ETFs are similar to industry ETFs in the fact that they are targeted to a certain area of the market. However when you purchase a commodity ETF like gold or energy, you do not actually buy the commodity, the ETF consists of derivative contracts in order to emulate the price of the underlying commodity. So, when you buy an oil ETF, you are actually investing in oil without setting up a mining drill in your backyard.
There are some types of ETFs that do not consist of equities. Very common with commodity ETFs, some funds are made up of derivative contracts like futures, forwards, and options. While the goal is to emulate an investment product, there are different ways to do so within the construction of ETFs. Assets in the fund can either be individual companies or in these cases derivative products.
Some types of ETFs track a certain investment style or market capitalization (large-cap, small-cap, mid-cap). Style ETFs are most actively traded in the United States and exist on growth and value indexes developed by S&P / BARRA and Russell. So, if you have a certain investment goal based on a market-cap style, you may be able to reach your target with a style ETF like the SPDR Dow Jones Large Cap Value ETF (ELV) which tracks the Dow Jones U.S. Large Cap Value Index
The multitude of available bond ETFs runs the gamut. International, government, and corporate to name a few. Bond ETFs have a difficult task when it comes to construction since they track a low-liquidity investment product. Bonds are not active on secondary markets since they are normally held to maturity, yet ETFs are actively traded products on exchange floors. However, ETF providers like Barclays have done their job with debt-based ETFs and created some successful bond funds like the SPDR Capital Long Credit Bond ETF (LWC) which gives investors opportunities in the bond market while still maintaining the benefits of ETFs.
Exchange traded notes, the little brothers of ETFs. While they are not truly a type of ETF, more of their own investment, people still lump them into the major ETF categories.
ETNs are issued by a major bank as senior debt notes. This is different from an ETF which consists of securities or derivative contracts. When you buy an ETN, you receive a debt investment similar to a bond. ETNs are backed by high credit rating banks so they are considered secure investment products, however the notes are not totally absent of credit risk.
When the market starts to plummet, investors tend to want to get short. However, trading account constraints can make that an issue. Margins may not allow that possibility if one is selling a naked investment or there may be a restriction on certain accounts against selling certain investments. Enter inverse ETFs, funds created to create a short position when you buy the ETF. They have an inverse reaction to the direction of the underlying index or asset.