Types of Exchange Traded Funds (ETFs)

Because exchange traded funds continue to gain popularity with every closing bell, it’s entirely possible the investment community will have too many kinds of ETFs to track. However, that is not entirely And a bad thing. If you look at the overall ETF market, you can safely categorize the majority of these investment funds into the most popular types of ETFs. This list will help understand which of these excellent funds makes the most sense for your overall investment strategy.

United States Market Index ETFs

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Market ETFs usually track a major market index and are some of the most active ETFs on an exchange floor. However, there are some market ETFs that track low-volume indexes as well. Keep in mind the goal of a market ETF is to emulate an underlying index, not outperform it. An example would be the QQQQ’s which tracks the Nasdaq-100 index.

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Foreign Market Index ETFs

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The U.S. is not the only country to have market index ETFs. There are many foreign ETFs to choose from as well. If you’re an investor looking for international exposure or to hedge against foreign investing risk, then country or region ETFs may be a good option. Two examples are EWJ, which tracks Japan’s Nikkei Index, and EWG which tracks the MSCI Germany Index.

Foreign Currency ETFs

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Foreign currency ETFs are funds that help investors gain exposure to foreign currencies without having to complete complex transactions. Currency ETFs are seemingly simple investment vehicles that track a foreign currency, similar to how a market ETF tracks its underlying index. In some cases, this type of ETF tracks a basket of currencies, allowing an investor access to more than one foreign currency.

Sector and Industry ETFs

Industry ETFs are types of ETFs that generally track a sector index representing a certain industry. They are perfect for gaining exposure to a certain market sector like pharmaceuticals without having to purchase the plethora of individual companies. Instead, it only takes one transaction to buy a fund like the PowerShares Dynamic Pharmaceuticals ETF (PJP) and instantly implement your ETF investing strategy.

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Commodity ETFs

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Commodity ETFs are similar to industry ETFs in that they are targeted to a certain area of the market. However, when you purchase a commodity ETF, like gold or energy, you do not actually buy the commodity, the ETF consists of derivative contracts in order to emulate the price of the underlying commodity. Therefore, when you buy an oil ETF, you are actually investing in oil without setting up a mining drill in your backyard.

Derivative ETFs

There are some types of ETFs that do not consist of equities. It's very common with commodity ETFs that some funds are made up of derivative contracts like futures, forwards, and options. While the goal is to emulate an investment product, there are different ways to accomplish this within the construction of ETFs. Assets in the fund can either be individual companies or, in these cases, derivative products.

Style ETFs

Some types of ETFs track a certain investment style or market capitalization (large-cap, small-cap, mid-cap). Style ETFs are most actively traded in the United States and exist on growth and value indexes developed by S&P/BARRA and Russell. So, if you have a certain investment goal based on a market-cap style, you may be able to reach your target with a style ETF like the SPDR Dow Jones Large Cap Value ETF (ELV) which tracks the Dow Jones U.S. Large Cap Value Index.

Style ETFs, the ETFs With Style

Bond ETFs

 The many available bond ETFs runs the gamut, from international to government to corporate, to name a few. Bond ETFs have a difficult task when it comes to construction because they track a low-liquidity investment product. Bonds are not active on secondary markets because normally they are held to maturity. However, ETFs are actively traded products on exchange floors. ETF providers, like Barclays, have done their job with debt-based ETFs and have created some successful bond funds like the SPDR Capital Long Credit Bond ETF (LWC). this offering gives investors opportunities in the bond market while still maintaining the benefits of ETFs.

ETNs — Exchange Traded Notes

Exchange-traded notes are the little brothers of ETFs. While they are not truly a type of ETF, because they are more of their own investment, people still lump them into the major ETF categories.

ETNs are issued by a major bank as senior debt notes. This is different from an ETF which consists of securities or derivative contracts. When you buy an ETN, you receive a debt investment similar to a bond. ETNs are backed by high credit rating banks so they are considered secure investment products. However, the notes are not totally absent of credit risk.

Inverse ETFs

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When the market starts to plummet, investors want to get short. However, trading account constraints can make that an issue. Margins may not allow for that possibility if someone is selling a naked investment or ​if there is a restriction on certain accounts against selling certain investments. Enter inverse ETFs, funds created to create a short position when you buy the ETF. They have an inverse reaction to the direction of the underlying index or asset.

Leveraged ETFs

Leveraged ETFs are a very controversial fund and are better suited for the advanced ETF trading strategy. A common misconception is that they will produce exponential annual returns when in fact they are constructed with the goal of creating a leveraged daily return on underlying indexes and assets. Even then, it is a goal, not an absolute. Therefore, before you add leveraged ETFs to your portfolio, conduct thorough research. Here are some good places to start.

Actively Managed ETFs

In the ongoing war between ETFs vs. Mutual Funds, there just may be a compromise, the Actively Managed ETFs. These combine all the benefits of both mutual and exchange-traded funds in one asset and eliminate some of the disadvantages. If you're curious, check them out yourself.

Dividend ETFs

Some ETFs target equities that pay dividends. Usually, dividend ETFs track a dividend index and the assets in the fund and index consists of a diverse range of dividend-paying stocks. But in some cases, the dividend stocks are segmented by market-caps or geographic locations.

Innovative ETFs

Because ETFs are gaining popularity on a daily basis, there are more and more innovations when it comes to these investment products. Some of the newer and more innovative funds include ETFs of ETFs, Volatility ETFs, and Tax-Deferred ETFs. Of course, these two are just the tip of the future ETF iceberg.

These ETF categories outline the majority of the different types of ETFs in the investing world. As this world continues to grow, so will the different variations. The good news is that if you are ready to get started with ETFs, you’ll have a lot of different ones to buy or sell.