Exchange Traded Funds

An exchange traded funds are very similar to mutual funds. However,the major difference between a mutual fund and exchange traded funds being that the net asset value (NAV) of mutual funds is calculated at the end of the trading every day whereas, in case of exchange traded funds are not calculated per day , there value is calculated instantaneously .

Mutual funds are not eligible to be traded in intra-day trading as their value is calculated at the end of the day. But, an exchange traded fund (ETF) can be traded at any time just akin to shares.

Another advantage is that the expense ratios for most ETFs are lower than those of the average mutual fund. When buying and selling ETFs, you have to pay the same commission to your broker that you'd pay on any regular order.

Exchange Traded Funds (ETFs) are growing in popularity as a method of investing, providing the opportunity for investors to diversify their portfolios while maintaining flexibility in trading that is similar to stocks.

ETFs can be classified into various types and all these types of ETFs allow the investor to diversify the portfolio.Mainly, ETFs can be classified into :

  • Index ETFs
  • Inverse and leveraged ETFs
  • Commodity ETFs
  • Currency ETFs
  • Actively managed ETFs
  • Exchange Traded Notes ( ETNs)

INDEX ETFs

Index ETFs means Exchange Traded Funds whose portfolio resembles index i.e. the portfolio is formed in proportion to the weightage of stocks in the underlying index . These are ETFs that use an index tracking approach generally follow a pre-selected index, called a benchmark, and the return on the ETF will closely correlate with that of the underlying index. The weightings used in the underlying index could be based on market capitalization of the constituents or on fundamental factors such as financial criteria. Index ETFs may also follow indices that adhere to a certain investment style, such as value or growth.

INVERSE AND LEVERAGED ETFs

Inverse ETFs are designed to seek daily investment results that correspond to the inverse daily performance of their underlying index or benchmark. To meet their investment objectives, inverse ETFs use a variety of derivatives such as futures contracts and index swaps to reproduce a daily result that is the opposite of the underlying index or benchmark.

Leveraged ETFs are designed to seek daily investment results to provide a multiple of the daily performance return of an underlying index or benchmark (for example, 200% the return). They are not intended to provide that same multiple of the return over the mid or long term. Investors should be aware that, while leveraged ETFs typically achieve their stated objective of a multiple of the daily performance of an underlying index on a daily basis, their returns can vary considerably from that stated objective if held for a period longer than one day.

COMMODITY ETFs

Commodity ETFs consists commodities such as energy (e.g., natural gas or oil), precious metals (e.g., gold, silver or platinum), or livestock and grains, either by
(i) holding the physical commodity directly,
(ii) tracking the performance of the spot market price through physical forward contracts, or
(iii) investing in or tracking the performance of commodity futures contracts. ETFs that hold the physical commodity provide exposure to the spot price of the commodity without the trouble of storing the commodity.

CURRENCY ETFs:

Currency ETFs provide exposure to currencies and can also hold either the actual currency or futures contracts. Some are designed to be long or short on one currency against others; some are designed to hold a mix of long and short futures positions among several currencies.

ACTIVELY MANAGED ETFs:

Index ETFs are generally designed around a passive strategy and therefore typically have lower management fees. Some ETF providers offer actively managed ETFs that operate more closely to the concept of a mutual fund.

EXCHANGE TRADED NOTES:

Exchange traded notes are debt obligations of the issuer and trade like ETFs. They do not guarantee any return of principal at maturity and do not pay any interest during their term. While they exhibit no tracking error in that their return at maturity is linked to the return of the underlying index (minus expenses), they do exhibit credit risk linked to the issuer. ETNs offer long and short or inverse exposure to commodities and currencies as well as leveraged exposure.