An ETF is an investment vehicle that combines key features of traditional mutual funds and individual stocks. ETFs are open-ended funds which like index mutual funds represent portfolios of securities that track specific indexes. A distinct difference is that ETFs trade like stocks and can be bought and sold (long or short) on an exchange and can employ the same trading strategies used with stocks. ETF is a single stock representing a portfolio of securities underlying the index which can be comprised of stocks, bonds, or other assets such as commodity. ETFs can track virtually any industry or sector of the stock market: big cap stocks, small cap stocks, dividend, growth, energy, tech, utilities, commodities, REITs.
ETFs can be classified in different investment approaches, which may include:
Index tracking approach
- ETFs that use an index tracking approach generally follow a pre-selected index, called a benchmark, and the return on the ETF will roughly correlate with that of the underlying index.
- Inverse ETFs is designed to perform as the inverse of whatever index or benchmark it is designed to track. These funds work by using short selling, trading derivatives such as futures contracts, and other leveraged investment techniques.
- Leveraged ETFs utilize financial derivatives and debt to amplify the returns of an underlying index. They are designed to return a multiple of the return of a market index price on a daily basis.
Actively managed approach
- The ETFs operate more closely to the concept of a mutual fund. The ETFs engaged an active manager making investment decisions, often with the objective of outperforming rather than tracking a particular benchmark index, but usually with lower management fees than a traditional mutual fund.