Types of exchange-traded funds

Exchange-traded funds (ETFs) have flourished in popularity as a highly favorable investment vehicle. ETFs allow you to diversify by holding a small position in hundreds or thousands of investments within one ETF. Many investors like ETFs because while they’re relatively similar to mutual funds in terms of diversification, tax-efficiency, and low costs, you can buy and sell ETFs on an exchange, just like stocks.

While ETFs were initially designed as passive investments, there has since been significant growth in the availability of actively managed ETFs.¹  As the ETF landscape continues to evolve, so has the ability for investors to build a tailored ETF portfolio.

Here’s a look at the many types of ETFs available:

One of the most common types of ETFs, equity ETFs invest in stock and aim to track, match, or even outperform a particular equity market index such as the S&P 500 or the NASDAQ.

ETFs, especially equity ETFs, can provide a shareholder with additional levels of diversification in subcategories:

• Market capitalization (market cap): ETFs based on a company’s size.  
  • Large-cap ETFs typically invest in companies with a market cap of $10 billion or more.
  • Medium cap ETFs invest in companies with a market cap of $2 billion to $10 billion.
  • Small cap ETFs invest in companies with a market cap of less than $2 billion.
• Geographical location: These funds focus on a particular country, region, or group of countries.
  • International ETFs invest in companies based outside of the United States.
  • Regional ETFs target specific regions like Asia or Europe.
• Sector ETFs narrowly focus on a particular market or subset of an asset class. These can be especially helpful to investors looking to capitalize on a particular industry or field while not being familiar with individual companies. For example, a sector ETF could concentrate on funds from the health or tech industry.
• Investing Style: Growth vs. value
  • Growth ETFs invest in companies that are actively looking to increase their revenue.
  • Value ETFs invest in (typically more mature) companies that are considered to be worth more than their current market valuation.
  • Life stage ETFs may focus on companies at a specific growth stage, such as spin offs or recent IPOs.
• Passive vs. actively managed ETFs
  • Passively managed ETFs track the performance of a specific index.
  • Actively manage ETFs are professionally managed by a fund manager who selects specific investments to help achieve the fund’s investment strategies.

Non-equity ETFs invest in non-stock assets, such as alternatives, bonds, and commodities. Investing in non-equity ETFs can help diversify a portfolio by mitigating market volatility and potentially creating less risk and more stability.

• Bond ETFs are fixed-income funds that invest in bonds or bond indices including treasuries, municipal bonds, and corporate bonds.
• Commodity ETFs invest in commodities like oil, gold, or coffee.
• Currency ETFs invest in either a single currency or a basket of currencies.

Strategy-based ETFs are ETFs designed to follow a specific investment strategy to achieve a particular goal. For example:

• Leveraged ETFs might be designed to go up or down by twice as much as the S&P 500 stock index.
• Inverse ETFs aim to deliver the opposite results from those of the index, going down when the index rises, and vice versa. A leveraged inverse ETF might attempt to not only move in the opposite direction from its benchmark index, but to do so by two or even three times as much.

Strategy-based ETFs often use complex financial instruments such as derivatives to try to achieve their intended results. Those investments involve additional risks, which you should consider. Leveraged and inverse ETFs are designed to achieve their results on a daily basis. However, a given ETF’s performance can differ significantly from the daily results of the index it tracks.

In some cases, those differences can be dramatic; leveraged ETFs have even moved in the opposite direction from their benchmark. And even small differences can be magnified over time by the effects of compounding. As a result, such investments are typically not well suited for individual investors who plan to hold them for more than a day.

Before investing in an exchange-traded fund, carefully consider its investment objectives, risks, fees, and expenses. All of which you can find in the fund’s prospectus.

Article footnotes

¹ Will Active ETFs Outnumber Passive ETFs? | Morningstar, September 10, 2024, https://www.morningstar.com/funds/will-active-etfs-outnumber-passive-etfs

CRC# 3948200 11/2024