As we explained in our previous posting on ETF, there is a wide range of ETFs available on the market, including equity ETFs, fixed-income ETFs, commodity ETFs, currency ETFs, multi-asset ETFs, leveraged ETFs, etc. Before we established that most ETFs are index-based and seek to follow a specific index. For instance, Straits Times Index tracks stocks of the top 30 companies listed on the Singapore Stock Exchange. An ETF that tracks the Straits Times Index typically holds the same number of stocks as the Index. In general, whatever asset class is included in the ETF, the ETF follows the related index performance by comprising all or a representative sample of this index.
We will now examine several ETF types.
Equity ETFs track an index of equities. You may invest in ETFs that cover large or small businesses from various industry sectors or stocks from a specific country. Equity ETFs also allow an investor to select specific sectors of the economy that might be doing well at certain times, for example, biotech companies’ stocks or banking stocks.
Fixed-income ETFs track bonds’ indexes and a broad variety of fixed-income ETFs allow investors to put their money into a broad and liquid basket of bonds such as corporate bonds, government bonds, international bonds, and junk bonds. Fixed-income ETFs are generally viewed as steady sources of income with relatively low-risk levels; however, fixed-income ETFs have evolved to adapt investors’ new needs for a higher return, diversification, and mitigated risk.
Commodity ETFs follow the prices of commodities or commodity indexes. These commodities include natural resources, precious metals, and agricultural products. Some commodity ETFs do own the underlying commodity, allowing investors to gain an ownership stake in the stockpile of this commodity without having to facilitate a physical delivery of the asset or worry about storing and insuring it. For instance, Physical Swiss Gold Shares ETFs provide investors with the mentioned above options. Other commodity ETFs comprise a few futures contracts backed by the commodity. Commodity ETFs are viable instruments to diversify investors' portfolios and risks. Nevertheless, derivatives-backed commodity ETFs can be less transparent and riskier than Equity or Fixed-Income ETFs.
Currency ETFs are backed by a single currency, such as the US dollar, Euro, or a basket of currencies. An investor may buy a currency ETF thinking a currency ETF is likely to appreciate or add a hedge to his investment portfolio. Some ETFs that cover overseas markets provide an additional hedge against currency volatility risk.
These types of ETFs offer more growth potential than other ETF types but also carry much higher risk. Leveraged ETFs are backed by leverage funds seeking to maximize yields by borrowing more money to invest. These ETFs typically inform the investor about their leverage ratio. While a traditional ETF usually follows the securities in its underlying index with a 1:1 ratio, a leveraged ETF would typically have a 2:1 or 3:1 ratio. Leveraged ETFs are available for most indexes, such as the Nasdaq 100 Index and the Dow Jones Industrial Average (DJIA).
There are more categories of ETFs available on the market. In short, to make the investment decision, the investor considers a variety of asset classes and decides on a particular type of ETF to invest in after assessing the related risk and possible return.
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