Understanding Underlying ETF Holdings
ETFs can hold a variety of different financial instruments—from well-known, established stocks and baskets of stocks,
to fixed-income securities, various currencies, commodities
such as gold and silver, and derivatives securities such as
futures contracts. Each ETF that tracks to an underlying index
will invest in the type of securities that best suit that ETF
as well as the ETF sponsor’s desire for how to best provide
exposure to its particular market, sector or asset class.
Equity ETFs – Equity ETFs track to equity indices. They
generally invest in a basket of equity securities, either
domestic or international. Equity ETFs may allocate assets
to stocks and/or American Depository Receipts (ADRs) in
proportions that are dictated by the composition of the underlying
equity index. ETFs can also invest in derivatives that
provide exposure to a specific benchmark. Remember that
an ETF’s objective is to mirror its chosen index or benchmark
as closely as possible.
Equity ETFs can fall into several subcategories. Some invest
according to a specific market cap index (e.g. small-, mid- or
large-cap) or only within certain geographic areas or countries.
- Sector ETFs run parallel to sector equity indices (such
as for energy, financials, health care) and invest only in
stocks that focus the majority of their business within
those specific sectors.
- Style equity ETFs track to style indices, such as those
that only invest in growth stocks or only in value stocks.
- Other equity ETFs may track to special equity indices
that are composed of stocks with similar market characteristics,
such as those with annual dividends and/or
revenues above a certain predetermined level. Others
track to unique indices that utilize very specific investment
strategies.
Fixed-income ETFs – Fixed-income ETFs track to bond indices.
They generally invest in a basket of fixed-income securities,
either domestic or international. Depending upon the underlying
index, a fixed-income ETF may invest in a broad basket
of fixed-income securities or within a more narrowly focused
slice as determined by market cap, geographic region or
specific type of fixed-income securities, such as high yield
bonds or municipal bonds. The specific securities of a fixed-income ETF are determined by the underlying index.
Hard Asset Exchange Traded Products (ETPs) – Hard
asset ETPs do not generally track to underlying indices.
Instead, these exchange traded products generally invest in
some type of tangible asset, such as currencies or commodities,
as opposed to stocks or fixed-income securities. Unlike
equity or fixed-income ETFs, hard asset ETPs do not seek
to parallel a specific underlying index. Instead, exchange
traded products that invest in hard assets will track to changes
in the prices of their underlying hard asset.
- Commodity exchange traded products invest in hard
commodities such as gold or silver and maintain physical
vaults containing these precious metals.
- Currency exchange traded products invest in the
currencies of different countries and maintain accounts
into which each specific currency is deposited.
Other ETFs – Some ETFs will benchmark their holdings
and performance to a particular index but not directly hold
the constituents that comprise that index. Broad-based
commodity ETFs whose holdings are linked to a basket of
various commodities—such as wheat, aluminum, crude oil,
etc.—will often invest in a basket of futures contracts or other derivatives securities as will some ETFs that invest in
baskets of currencies. These futures contracts or derivatives
are structured to provide the desired exposure to a particular
commodity but operate more efficiently than having to secure
bushels of wheat, rolls of aluminum or barrels of oil.
- Limited Partnership ETFs – A few ETFs are structured
such that the underlying manager is a limited partnership,
which allows it to be registered as a commodity
pool operator. Under this structure, the general manager
is able to buy and sell futures contracts for commodities
(such as crude oil, precious metals or natural gas) and
currencies on the Chicago Mercantile Exchange, for
example. Again, unlike hard asset exchange traded
products, these ETFs will not hold physical commodities,
but rather trade futures on those underlying commodities.
- Hybrid Index ETFs invest in a combination of equity and
fixed-income securities. This category includes target
date funds.
- Leveraged ETFs typically seek to provide a higher return than could ordinarily be achieved just by following the
underlying index; the goal is often twice the return on
a daily basis. A leveraged ETF may invest in the same
companies as in the underlying index it tracks, but may
also invest in certain leveraged financial instruments and
derivatives such as equity index swaps, futures contracts
and options on various securities with the hopes of providing
additional exposure and multiplying returns.
- Inverse ETFs typically seek to offer an enhanced return
that moves in a direction opposite to the directional
moves of the underlying index; the goal could be twice
the inverse return on a daily basis. An inverse ETF may
engage in the short sales of securities and/or invest in
a variety of derivatives instruments such as equity index
swaps, futures and options.
ETFs: Number of Funds by Type
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