ETFs

Types of ETF

Learn about the different types of ETF, and how they can be part of a balanced portfolio.

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Please remember, investment value can go up or down and you could get back less than you invest. The value of international investments may be affected by currency fluctuations which might reduce their value in sterling.

What is an ETF?

An ETF, or Exchange-Traded Fund, is a type of fund that can be traded like shares on the stock market. Most ETFs follow a market index or benchmark.
 

Equity ETFs

These are ETFs that track an index of shares (also known as equities or stocks). The most popular equity ETFs track on an index associated with a specific country. For example, the UK’s FTSE 100 or the US S&P 500.

Investors can also buy ETFs that track regional or global indices. For example, if you wanted access to European shares, you could buy an ETF tracking the EUROSTOXX 50 index. If you wanted emerging market shares you could buy an ETF tracking the MSCI Emerging Market index.

Investors can also find ETFs that track just one “industry” or “sector” within these indices. For example, you can buy an ETF that tracks just the energy stocks in the S&P 500. These indices are usually “market capitalisation weighted,” meaning that bigger companies generally make up a larger part of the index.

We feature several equity ETFs in our Super 60 rated investment list.
 

Equal weighted equity ETFs

In recent years, it has become popular to access equities in ETF using alternatively weighted indices. For example, rather than go for an ETF tracking a market capitalisation weighted index, some investors opt for “equal weighted” ETFs, in which each of the ETFs holdings appear in the portfolio in equal size.

Investors in equal-weighted ETFs generally hope that smaller stocks in the index will perform better than the large ones.
 

Factor ETFs

Other equity ETFs try to provide investors exposure to so-called “factors”.

Factors refer to a set of common characteristics that certain shares supposedly have. For example, the “value factor” refers to stocks deemed to be cheap, while “low volatility” refers to stocks that have historically not seen much price volatility.

The hope is that these factors will provide returns greater than that of the wider market.
 

Thematic ETFs

As the name suggests, thematic ETFs allow you to invest in a certain “theme”. This can be something such as the rise of electric vehicles, increased use of cloud computing or the digital transformation of education.

The best way to view thematic investing is as an attempt to pre-empt the big future trends of the world and then invest in the sort of companies that will, in theory, benefit from this.

Thematic ETFs are often confused with sector ETFs. One way to think about the difference is that thematic ETFs are trying to provide exposure to “sectors of the future”.
 

ESG ETFs

ESG stands for environmental, social and governance. ESG ETFs usually follow a normal index of equities, such as the S&P 500, but with an added “ESG screen”.

This means that some stocks seen as going against certain ESG principles are excluded or given a lower weighting. Stocks deemed to have good ESG credentials are given a higher weighting. Methodologies, however, vary widely and you should always read the ETFs factsheet to understand what you are investing in.
 

Bond ETFs

Bonds are generally lower-risk investments than shares. Bond ETFs can therefore provide a steady, low-risk option by investing in a range of bonds. Investors can opt for very low risk government bonds, slightly riskier highly rated corporate bonds or highly risky so-called ‘high yield’ corporate bonds.
 

Commodity ETFs

Commodity ETFs (or sometimes ETCs) allow investors to gain exposure to things such as gold, oil or agriculture, among other things. Investors can opt for an ETF tracking a broad basket of commodities or they can go for one tracking the price of one specific commodity.

These can be more volatile than other types of ETF. Nonetheless, some people include them as a way to diversify their portfolio.
 

Alternative asset ETFs

Alternative ETFs refers to any ETF that invests in assets outside of the core standard three standard: stocks, bonds and cash. The obvious one here is commodities. However, alternative assets can also include areas such as property, private equity and venture capital.

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