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Lesson 7: What are ETFs

Lesson 7: What are ETFs

Trade ETFs to get diverse exposure to a range of markets – including indices, sectors, commodities and currencies. Find out what ETFs are and how to open your first position.

ETFs are one of the most popular investment products in the world today. Like traditional managed funds or mutual funds, they give investors access to a diverse range of securities, but they are much more cost-effective. Unlike traditional funds, they can be traded like any regular stock, which puts more control in the hands of the investor. Let’s look at how ETFs work and examine some of the pros and cons.

There is quite a bit you should know before you dive in. If you want to invest in ETFs right away, here is a quick guide:

  • Decide how to invest in ETFs - The most popular include trading an ETF with derivatives
  • Select your ETFs – With CAPEX.com you can choose from an offering of up to 50 CFDs on top ETFs.
  • Take your position - Create an account with us to start leveraged ETF trading.

For more info about what is an ETF and how it works, you can discover everything you need to know in this guide.

What is an ETF

An exchange-traded fund is a basket of securities — stocks, bonds, currencies, commodities, indexes, even cryptocurrencies, or some combination of these — that you can buy or trade through a broker. The fund will either physically buy the assets it is tracking or use more complicated investments to mimic the movement of the underlying market.

ETFs offer the best attributes of two popular assets: They have the diversification benefits of mutual funds while mimicking the ease with which stocks are traded.

An ETF gives you a way to buy and sell a basket of assets without having to buy all the components individually. The ETF provider owns the underlying assets, designs a fund to track their performance, and then sells shares in that fund to investors. Shareholders own a portion of an ETF, but they don’t own the underlying assets in the fund. Even so, investors in an ETF that tracks a stock index get lump dividend payments, or reinvestments, for the stocks that make up the index.

While ETFs are designed to track the value of an underlying asset — be it a commodity like gold or a basket of stocks such as the S&P 500 — they trade at market-determined prices that usually differ from that asset. What’s more, because of things like expenses, longer-term returns for an ETF will vary from those of its underlying asset.

You can trade an ETF to track a sector, an index, stocks from a specific country, a commodity, a currency, or fixed income markets.

Many ETFs are designed to track the underlying assets, but some funds handpick the assets they track. With CAPEX you can trade ETFs via CFDs.

How to take a position on ETFs

ETFs trade through both online brokers and traditional broker-dealers.

Trading an ETF with derivatives

Trading ETFs is a way to get exposure to shorter-term price movements within certain sectors. When you trade ETFs with CFDs, you can use leverage to get amplified exposure to the ETF of your choice.

As a result, CFDs enable you to open a position for just a fraction of the cost of traditional investing. This means that, while leverage can magnify your profits, it can also magnify your losses. This is because loss is calculated based on the full size of the position rather than the cost of opening that position and can far outweigh any initial deposit, so it is important to create a risk management strategy before you trade.

Buying ETFs directly

You can also typically purchase ETFs directly. A brokerage account allows investors to buy shares of ETFs just as they would buy shares of stocks.

This is a longer-term form of gaining exposure to the movements of a specific market or sector.

Investors may opt for a traditional brokerage account, while traders may opt for derivatives featuring.

Traders can not only open the more traditional ‘long’ position, but they can take advantage of markets that are falling in price too – known as going ‘short’. This opens a whole other avenue of potential profit while increasing the risk.

>> Learn more about CFD Trading

Examples of popular ETFs

The first ETF was the SPDR S&P 500 ETF (SPY), which tracks the S&P 500 Index, and which remains an actively traded ETF today.

Other popular ETFs to watch are:

  • The SPDR Dow Jones Industrial Average (DIA) (“diamonds”) represents the 30 stocks of the Dow Jones Index.
  • The iShares MSCI World ETF (EEM) seeks to track the investment results of an index composed of developed market equities.
  • ProShares Bitcoin Strategy ETF (BITO) is the first U.S. bitcoin-linked ETF offering investors an opportunity to gain exposure to bitcoin returns in a convenient, liquid, and transparent way.
  • Sector ETFs track individual industries and sectors such as energy (XLE), technologies (XLK), utilities (XLU), or financial services (XLF).
  • Commodity ETFs represent commodity markets, including gold (GLD), silver (SLV), or crude oil (USO).

>> Best ETFs for 2022

The Big 5 ETF Issuers

The types of ETFs are endless, ranging from bond ETFs and market ETFs to inverse ETFs, foreign market ETFs, and alternative ETFs.

Vanguard‘s portfolio passed the $1 trillion mark in ETF assets under management (AUM). BlackRock (BLK), which sponsors the iShares ETFs, is the only other firm at that elite level.

There are five issuers with $100 billion or more in ETF assets under management:

  • BlackRock: $2.117 trillion
  • The Vanguard Group: $1.619 trillion
  • State Street Corp., the sponsor of SPDR ETFs: $881 billion
  • Invesco Ltd.: $308 billion
  • Charles Schwab: $214 billion

The Biggest ETFs

All 50 of the biggest ETFs, which range from $23 billion to $329 billion in AUM, are offered by these five top issuers. The five largest funds are:

  • SPDR S&P 500 ETF Trust (SPY) from State Street: $329 billion
  • iShares Core S&P 500 ETF (IVV) from BlackRock: $249 billion
  • Vanguard Total Stock Market ETF (VTI): $213 billion
  • Vanguard S&P 500 ETF (VOO): $194 billion
  • Invesco QQQ Trust (QQQ): $152 billion

Among the 50 largest ETFs, BlackRock offers 21, Vanguard sponsors 19, State Street issues six, and Invesco has one.

Types of ETFs

Distinct types of ETFs are available to investors that can be used for income generation, speculation, and price increases, and to hedge or partly offset risk in an investor’s portfolio. Here is a brief description of some of the ETFs available on the market today.

Stock ETFs

Stock ETFs comprise a basket of stocks to track a single industry or sector. For example, a stock ETF might track automotive or foreign stocks. The aim is to provide diversified exposure to a single industry, one that includes high performers and new entrants with potential for growth. Unlike stock mutual funds, stock ETFs have lower fees and do not involve actual ownership of securities.

Industry/Sector ETFs

Industry or sector ETFs are funds that focus on a specific sector or industry. For example, an energy sector ETF will include companies operating in that sector. The idea behind industry ETFs is to gain exposure to the upside of that industry by tracking the performance of companies operating in that sector. One example is the technology sector, which has witnessed an influx of funds in recent years. At the same time, the downside of volatile stock performance is also curtailed in an ETF because they do not involve direct ownership of securities. Industry ETFs are also used to rotate in and out of sectors during economic cycles.

Geographic ETFs

Geographic ETFs enable you to track assets in a specific region. For example, you can trade in a US ETF that grants you exposure across all the US indices, an MCSI ETF that includes Taiwan companies, or an international ETF if you are looking to diversify your portfolio.

Commodity ETFs

As their name indicates, commodity ETFs invest in gold, oil, and other commodities. Commodity ETFs provide several benefits. First, they diversify a portfolio, making it easier to hedge downturns. For example, commodity ETFs can provide a cushion during a slump in the stock market. Second, holding shares in a Gold ETF or Oil ETF is cheaper than physical possession of the commodity. This is because the former does not involve insurance and storage costs.

Currency ETFs

Currency ETFs are pooled investment vehicles that track the performance of currency pairs, consisting of domestic and foreign currencies. Currency ETFs serve multiple purposes. They can be used to speculate on the prices of currencies based on political and economic developments in a country. They are also used to diversify a portfolio or as a hedge against volatility in forex markets by importers and exporters. Some of them are also used to hedge against the threat of inflation. There is even a Bitcoin ETF.

Blockchain ETFs

Blockchain ETFs are one of the ways to get exposure to cryptocurrency and blockchain technology without investing in cryptocurrencies. These funds track stocks of companies that invest in blockchain technology and are also available in the traditional markets.

Inverse ETFs

Inverse ETFs attempt to earn gains from stock declines by shorting stocks. Shorting is selling a stock, expecting a decline in value, and repurchasing it at a lower price. An inverse ETF uses derivatives to short a stock. They are bets that the market will decline. When the market declines, an inverse ETF increases by a proportionate amount. Investors should be aware that many inverse ETFs are exchange-traded notes (ETNs) and not true ETFs. An ETN is a bond but trades like a stock and is backed by an issuer such as a bank. Be sure to check with your broker to determine if an ETN is a good fit for your portfolio.

Leveraged ETFs

A leveraged ETF seeks to return some multiples (e.g., 2× like SQQQ or 3× like TQQQ) on the return of the underlying investments. For instance, if the S&P 500 rises 1%, a 3× leveraged S&P 500 ETF will return 3% (and if the index falls by 1%, the ETF will lose 3%). These products use derivatives such as options or futures contracts to leverage their returns. There are also leveraged inverse ETFs, which seek an inverse multiplied return.

What you need to know before you invest in ETFs

ETFs make up 30% of all U.S. trading in terms of value, according to Barron’s. Investors have flocked to them because of their simplicity, relative cheapness, and access to a diversified product.

Today, there are hundreds of ETFs traded regularly on major exchanges. There are both positive and negative aspects of ETFs, a smart investor should consider both elements before investing.

Advantages of ETFs

  • Easy diversification – get exposure to an entire market, country, or region with one trade.
  • ETFs are a cost-effective investment product – it only takes one transaction to trade fully. diversified index. The cost of investing in ETFs attracts lower fees (lower management expense ratio) than investing in actively managed equity funds, and even some equity index funds. A low minimum initial investment of $500 (for ASX-listed ETFs).
  • Leverage and shorting – just like shares, ETFs can be bought or sold. They can also be traded through gearing facilities such as a margin loan or CFDs. While leverage can increase exposure and profit potential it can also increase the risk.
  • Unlike managed funds, ETFs do not have minimum holding periods or early-withdrawal fees
  • ETFs hold the underlying securities in a trust separately from a custodian.
  • ETFs, particularly index funds, aim to disclose their holdings regularly so you can see exactly what you hold in your portfolio.

Risks of ETFs

  • Commissions and Trading Fees - experts have argued that ETFs trade as short-term speculations. Frequent commissions and other trading costs, therefore, erode investor returns.
  • Currency risk – investing in ETFs with an international focus exposes your capital to currency risk as well as local equity returns.
  • Liquidity – liquidity varies between ETFs and it influences the buy/sell spread (or cost) you’ll encounter when trading.
  • Tracking error – the return on the portfolio may deviate from the return on the index or benchmark tracked. These errors are more significant when the ETF employs a strategy other than full replication of the underlying index.

How to Trade CFDs on ETFs with CAPEX.com

Here’s how to trade an ETF in less time than it takes to eat dinner at your favorite restaurant.

  • Log in to your account or create an account
  • Go to the ETF section and choose your favorites
  • Set your trade size
  • Choose direction (Buy or Sell) based on your assessment of the influencing factors
  • Place your trade!
ETF Trading
Source: CAPEX Webtrader

FAQs

Are ETFs a good investment?

ETFs have become incredibly popular investments for both active and passive investors alike. While ETFs do provide low-cost access to a variety of asset classes, industry sectors, and international markets, they do carry some unique risks.

Are ETFs good for beginners?

Exchange-traded funds (ETFs) are ideal for beginner investors due to their many benefits such as low expense ratios, abundant liquidity, range of investment choices, diversification, low investment threshold, and so on.

Why should I buy an ETF?

ETFs have several advantages over traditional open-end funds. The 4 most prominent advantages are trading flexibility, portfolio diversification and risk management, lower costs, and tax benefits.

What is the downside of ETFs?

There are many ways an ETF can stray from its intended index. That tracking error can be a cost to investors. Indexes do not hold cash but ETFs do, so a certain amount of tracking error in an ETF is expected. Fund managers generally hold some cash in a fund to pay administrative expenses and management fees.

Do ETFs pay dividends?

Dividends on ETFs. There are 2 basic types of dividends issued to investors of ETFs: qualified and non-qualified dividends. If you own shares of an exchange-traded fund (ETF), you may receive distributions in the form of dividends. These may be paid monthly or at some other interval, depending on the ETF.

What was the first exchange-traded fund (ETF)?

The first exchange-traded fund (ETF) is often credited to the SPDR S&P 500 ETF (SPY) launched by State Street Global Advisors on Jan. 22, 1993. There were, however, some precursors to the SPY, notably securities called Index Participation Units listed on the Toronto Stock Exchange (TSX) that tracked the Toronto 35 Index that appeared in 1990.

How many ETFs are there?

The number of ETFs, along with the number of assets that they control, has grown dramatically over the past two decades. In 2020, there were an estimated 7,602 individual ETFs listed globally, up from 7,083 in 2019—and only 276 in 2003.

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