Types of ETFs

Till now, we have discussed the basics of ETFs like the meaning of ETFs, how we can buy and sell them, and how they are created. Now let’s shift our focus to the types of ETFs available. There are multiple types based on the structure of the ETF, management of the ETF, and underlying asset class of the ETF.

In this article, we will discuss these types in more detail. So, let’s dive in!

ETF Types: Based on Structure

Based on the structure, ETFs can be divided into 2 types.

Physical ETFs: 

In a physical ETF, the fund holds the actual underlying securities. An ETF tracking Nifty 50 will hold all the underlying constituents of Nifty 50. So far, in this series, we have made an implicit assumption that ETFs are physical in structure. Not a wrong assumption because all ETFs in India have a physical structure.

Synthetic ETFs:

Synthetic ETFs are an interesting variant. Just like any other ETF, a synthetic ETF is designed to replicate the return of a selected benchmark. However, instead of holding the underlying securities or assets, they use derivative contracts like swaps to track the index.

Synthetic ETFs, in general, have a lower tracking error than physical ETFs and are especially useful in tracking indices where the underlying securities are not very liquid. However, synthetic ETFs have counterparty risk. Synthetic ETFs were once very popular in Europe but have declined in popularity since the financial crisis of 2008.

ETF Types: Based on Management Style

Based on the management style, ETFs can be divided into below mentioned types.

Passive Management

These are ETFs that are set up to track passive benchmark indices like Nifty 50 or Nifty Next 50. We include ETFs that track mid and small-cap indices in passive management.

Actively managed ETFs

In an active ETF, the Fund Manager can take discretionary calls. The objective is to outperform the benchmark rather than track it. The most famous (or infamous) example of an actively managed ETF is ARK Innovation ETF. The expense ratio of these ETFs is similar to actively managed mutual funds.

International ETFs  

These ETFs hold securities that trade outside India. An example would be an ETF tracking S&P 500 Index.

Thematic ETFs

ETFs in this category track thematic or sectoral indices. An ETF tracking the Nifty IT index falls under this category. The expense ratio of these ETFs tends to be higher than passive ETFs.

Smart beta ETFs

ETFs in this category track a single-factor index or a multi-factor index. We have devoted an entire blog to smart-beta ETFs. The expense ratio of these ETFs is higher than passive ETFs.

Specialty ETFs

Two popular types in this category are leveraged ETFs and inverse ETFs. Inverse ETFs go up when the target index goes down thus allowing investors to take bearish calls without having to short the stocks. Leveraged ETFs aim to maximize returns by borrowing more money (leverage).

Technically, International, thematic, and smart-beta ETFs are also passive ETFs because they track a particular index, and the fund manager does not have the power to deviate from the benchmark. But we have kept them as distinct categories. Also, it should be noted that smart-beta ETFs are not actively managed ETFs.

ETF Types: Based on Asset Class

Based on the asset class, ETFs can be divided into below mentioned types.

Equity ETFs

These ETFs track equity indices (where underlying securities are stocks). These are the most common types of ETFs available in the world.

Fixed Income ETFs

These are ETFs that track fixed-income indices. Fixed-income ETFs can be further categorized based on type (Government Securities or Corporate Bonds) and duration (short-term, long-term). It can also be a target maturity or a constant maturity ETF.

Commodity ETFs

These ETFs track prices of a particular commodity – Gold, Silver, or Oil. However, commodity ETFs can be less transparent than index ETFs. The expense ratio of commodity ETFs is also higher than equity and bond ETFs.

Currency ETFs

Currency ETFs will invest in either a single currency, like the US dollar, or a basket of currencies.

Note that all the types of ETFs discussed in this article are not available in India. So, in the next article, we will discuss the ETF options available in India.

FAQs

How can I buy and sell ETFs?

ETFs can be bought and sold like stocks on a stock exchange. You can purchase ETFs through your brokerage account or online trading platform.

Are all ETFs passive investments?

ETFs can be either passive or active investments. Passive ETFs track an underlying index or asset, while active ETFs are managed by a fund manager who aims to outperform the market.