The exchange traded fund (ETF) landscape has come a long way, and it is still adapting and providing new, innovative ways to invest. It may be prove helpful to revisit the basics to better your understanding about ETF investing.
Daphne Gu and Jane Li for FundQuest recently provided a whitepaper to help investment professionals better understand ETFs and select the type of ETF most appropriate for client portfolios.
As of Nov. 30,there were 819 U.S.-listed ETFs with a total of $751,962 billion in assets under management. The whitepaper found that roughly 78% of ETF assets are in equities, 12% of assets in bonds, 9% of assets in commodities and the rest in other specialty themes. (More on ETFs in November).
Among other items of note in the report:
- Back in 2008, the ETF marketplace saw the advent of the leveraged ETF. Leveraged ETFs were designed to multiply returns but it also increases risk, especially during times of high volatility. Furthermore, holding the ETF for more than one day may result in returns that deviate from what is expected. (Special report on leveraged ETFs).
- Actively managed ETFs also made their first appearance in 2008. This fund type is similar to actively managed mutual funds, with the exception that the Securities and Exchange Commission (SEC) requires the funds to provide full transparency. (More on actively managed ETFs).
- ETFs are primarily used as a passive tool to track a specific index, and the security’s weight in the index is often determined by its respective market capitalization. About 95% of all ETFs are market-cap weighted.
- Performance risk in ETFs is quantified by an ETF’s tracking error – the performance difference between the ETF and its underlying benchmark. (Reasons why tracking error occurs).
- An ETF’s tax-efficiency comes from its low turnover, thanks to its index-tracking nature, as well as the fact that there’s no need to sell securities to meet redemptions.
- Investors also benefit from the greater liquidity due to intraday trading. However, some ETF themes were not well received and suffer from low trading volumes. (How to use ETFs to minimize taxes).
- Bond ETFs follow a different kind of index. A bond index is usually made of tens of thousands of issues, and meticulous research and portfolio management skills are needed to operate a successful bond ETF. (More on bond ETFs).
- The three most valuable types of screening tools available to investors include: holding-based style analysis, which shows the changes in an ETF’s holdings over time, risk-adjusted return, which combines the views of both return and volatility, and upside/downside analysis, which captures an ETF’s performance relative to its benchmark. It is important to note an ETF’s sector exposure when achieving a specific portfolio diversification.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.