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ETF Funds: Which ETF is Right for You?

When researching ETFs, read the prospectus and information found on the issuer’s website. There are many different types of ETFs, depending on what the fund is tracking, but also how the securities are weighted, if there is any additional exposure to risk, etc. Make sure you understand what exactly you are buying before investing.

ETF types

ETF Index

The most common type of ETF, an index ETF, tracks a specific US or foreign stock index (for example, NASDAQ 100, FTSE 100, S&P 500, Russell 2000, etc.). There is a wide variety of indexed ETFs for investors to choose from.

Sector / Industry ETF

These ETFs represent a specific sector (industry group), e.g. Eg technology, energy, materials, industry, health, finance, utilities, consumer staples, etc. They track the collective performance of that industry. As with most other types of ETFs, there are US, foreign, and global sector ETFs.

Specific size ETFs

These ETFs are defined by the market capitalization of the individual stocks within. For example, large caps (generally more than $ 10 billion in market capitalization), mid-caps ($ 2 billion to $ 10 billion), small caps ($ 300 million to $ 2 billion) ), microcaps ($ 50 billion). thousand – $ 300 thousand).

Country specific ETF

These ETFs track the performance of the markets of an individual country or, in some cases, an entire region (for example, Eastern Europe, Eurozone, Latin America, Asia, etc.). There are numerous international ETFs that are listed on both US and foreign stock exchanges.

Commodity ETF

Commodity ETFs track the performance of a commodity (eg oil, natural gas, gold, silver) or a basket of commodities (such as precious metals, base metals, agricultural commodities, etc.).

Currency ETF

A currency ETF offers investors the ability to track the performance of various currencies around the world, such as the US dollar, Japanese yen, British pound, euro, etc. (It’s important to note that while FOREX is essentially a 24-hour market, currency ETFs have the downside of being available to trade only during stock market trading hours.)

Fixed income ETF

ETFs that track indices of corporate bonds or treasuries.

ETFs by weighting model

Weighted equally

Most ETFs (and indices) are weighted by market capitalization, which means that larger companies have a much higher representation in the index and a greater influence on price movement. Most of the capitalization of the index is concentrated in the main positions.

Some providers now offer ETFs of equal weighting (index and sector), which provide a broader representation of the companies within the index. Each stock is initially weighted the same, allowing you to spread your risk equally across all stocks in the index. It also means you get more exposure to small and medium-sized companies, which often outperform larger caps.

The other problem with market cap weighting is that stocks that have risen rapidly in price and have become overvalued will have a higher weight in the index. (The higher a stock’s valuation, the higher its market capitalization.) Equal-weight ETFs avoid overweight stocks that trade above fair value.

To maintain the same weight, an ETF of equal weight needs a periodic rebalancing (usually done on a quarterly basis).

This means that such ETFs (compared to traditional index ETFs) tend to have higher expense ratios, as well as higher bid and ask spreads (as they tend to trade finer). Since rebalancing involves selling the stocks that have appreciated the most, it results in higher transaction fees, but also more tax liability (due to the realization of capital gains).

While equally weighted ETFs are a great addition to the ETF universe, they tend to be slightly more expensive and less tax efficient, all of which can result in a lower compound return. Investors should carefully examine whether these ETFs will benefit their portfolio.

Fundamentally weighted

While traditional indices are weighted by market capitalization, fundamentally weighted ETFs offer an alternative, weighting companies based on fundamental factors (such as book value, earnings, dividends, etc.).

Some ETFs are weighted to fit a certain investment style. For example, there is a range of value ETFs that companies select based on price / earnings, price / book combinations, price / cash flow ratios, dividend yield, etc.

As we’ve seen with the same weighting, ETFs that are weighted differently than market cap tend to have higher portfolio turnover (as they have to buy and sell shares as prices fluctuate). This translates into higher transaction costs and lower tax efficiency; both generally apply to fundamentally-weighted ETFs as well.

Actively managed ETFs

Actively managed ETFs have been around since 2008 and have so far not proven very popular with investors. These ETFs, instead of tracking an index, use a manager to select the securities to include in the fund.

Actively managed ETFs have similar problems to actively managed traditional mutual funds … expense ratio and transaction costs are higher, and tax liabilities are higher.

Therefore, the manager has to add enough value to make up for this. Now, as we can see with most mutual funds, that rarely happens. Since most managers do no better than market averages, the returns from actively managed ETFs can be questionable (at least until we start to see some history for these funds).

While ETFs were first introduced as low-cost, passive, transparent investment vehicles, there are also a number of very complex ETFs today. Some of them have proven very popular with experienced traders and investors, but it is essential that you fully understand the risks before investing in these more exotic vehicles.

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