For investing in ETFs there is a wide choice because there are over 5000 listed ETFs. This wide choice however can be confusing and therefore it is good to know that an ETF is nothing more than, simply to make it, an investment fund, a sort of collector. Let’s see the top 4 types of ETFs to invest in: equity ETFs, bond ETFs, commodity ETFs, leveraged and inverse ETFs.
ETFs are among the most important and also most accessible investment instruments. Explaining what ETFs are and why investing is very long and complex, for this you can find several articles on the topic on Finance Drops: the introductory one that should be read first is What are ETFs and why invest in them, then there are others – like the one you are reading – dedicated to specific ETFs.
ETFs can be divided into four main types: equity ETFs, bond ETFs, commodity ETFs and leveraged and reverse ETFs. I will try to explain the main characteristics of each one, so that the choice on which to invest can be more aware.
Obviously they are ETFs that invest in stocks exchange. In detail, equity ETFs can in turn be identified in three categories.
Equity ETFs that track market indices
They are ETFs that replicate market indices such as S&P 500, Dax30, FTSE MIB, Nikkei225, Cac40 etc… In practice, these are ETFs that replicate the equity Blue Chips, the most capitalized securities of the stock exchanges in the world. Equity ETFs that track market indices are ideal for the novice investor as they are very simple to understand.
Equity ETFs that track a sector index
These are ETFs that replicate a specific sector, for example the US banking sector, the european energy sector or the mining sector at a global level. There are also sectoral ETFs that replicate even more specific sectors such as video games, cannabis or fashion.
With these ETFs, the investor is exposed to one or more sectors of the economy, perhaps leaving the others out because he believes they have less potential for revaluation in short, medium or long term. In this case, however, equity ETFs that track a sector index are not suitable for novice investors, but for those who already have adequate knowledge of the financial markets and their dynamics.
ETFs that invest in real estate
REIT ETFs are nothing more than real estate funds, and therefore ideal for those who want to invest in the sector without having to invest in a Real Estate Investment Trust. This investment sector is very interesting and for this reason I refer you to these two introductory guides: Investing in ETFs real estate and Investing in the real estate with REITs.
ETFs that invest in bonds should be chosen by asking at least the following two questions:
- who issues the bonds, governments or companies? Generally, unless it is an emerging country, the bonds issued by governments are more secure than those of companies.
- what is the bond rating? The higher the rating, the more secure the bonds are, but the recognized returns are also lower
In general, moreover, it is good for those who focus on bond ETFs to invest in high liquidity securities, that is, with a high volume of daily trades.
Commodities ETFs invest in a commodity basket, but it should be noted that investing in an ETF that tracks commodities is not exactly the same as investing in an ETF that tracks a stock index.
Physically replicated ETFs are very simple. They actually purchase the raw material and store it in a warehouse. This type of replica occurs only for precious metals (gold, silver, palladium and platinum).
Synthetic replication ETFs invest in a market index, in this case a commodities market.
Futures based ETFs involve all commodities and are far more complex. ETFs purchase futures contracts linked to the underlying which is replicated.
ETFs invest in a basket of commodities, instead ETCs invest in a commodity: they are therefore simpler investment instruments and must be analyzed differently.
Theoretically, the contract purchased should allow the ETF to link its performance to that of the spot commodity price. In practice this is not the case, since every contract that expires must be replaced (rolling) with another that will not necessarily have the same price; it may be higher or lower depending on whether the raw material price curve is in contango or in backwardation. The simplest ETFs roll on the closest contract expiration to minimize costs as much as possible, but they cannot reset them.
For a commodity ETF therefore the three drivers of a return are the trend of the spot price, the rolling and the cash return. Being in most of the time in contango (therefore with the future price higher than the spot one) the rolling turns into a cost at each change of contract. Cost that is passed on to the investor in a lower participation in the future trend of the commodity price.
There are structured commodity ETFs (ETFS), which differ from normal ETFs commodities for a more “structured” management. In practice, in addition to having the benchmark as a reference, managers adopt strategies to optimize the use of leverage and have a stronger money management plan. These are therefore qualitatively better tools, which obviously have a higher cost, such as for commissions.
As said, commodity ETFs are more suitable investments for experienced investors, although even beginners can easily find ETFs with good performances.
Leveraged and inverse ETFs
Leveraged ETFs and reverse ETFs (short ETFs) are the riskiest ones because they have financial derivatives as their underlying: with a short ETF on the S&P 500 you earn when the US equity index falls, while the leveraged ETF adds a multiplier effect that amplifies gains and losses. For example, a 2x leveraged ETF on the FTSE MIB allows you to expose yourself on the italian blue chips equity index with a double risk compared to the list.
There are also leveraged and reverse ETFs (i.e. the two types combined), such as a 2x short ETF that allows you to earn double from the falls but also to multiply the potential losses by two.