Complete Guide To Investment Companies, Funds And REITs


Exchange-Traded Funds - Common ETFs

From an investment strategy standpoint, traditional exchange-traded funds (ETFs) are designed to track indexes. ETFs are available in hundreds of varieties, tracking nearly every index you can imagine; they offer all of the benefits associated with index mutual funds, including low turnover, low cost and broad diversification, plus their expense ratios are significantly lower.

Commodities are a separate asset class from stocks and bonds, so investing in commodity ETFs can provide extra diversification in a portfolio. Because they are hard assets, these ETFs can also provide protection against unexpected inflation.

Commodity ETFs can be divided in three types:

  1. ETFs that track an individual commodity like gold, oil or soybeans,
  2. ETFs that track a basket of different commodities and
  3. ETFs that invest in a group of companies that produce a commodity.

Commodity ETFs either hold the actual commodity or purchase futures contracts. ETFs that use futures contracts have uninvested cash that is used to purchase interest-bearing government bonds. The interest on the bonds is used to cover the expenses of the ETF and to pay dividends to the holders.

Related Readings:

Currency ETFs are designed to track the movement of a currency in the exchange market. The underlying investments in a currency ETF will be either foreign cash deposits or futures contracts. ETFs based on futures will invest the excess cash in high-quality bonds, typically U.S. Treasury bonds. The management fee is deducted from the interest earned on the bonds.

Several choices of currency ETFs are available in the marketplace. An investor can purchase ETFs that track individual currencies such as the Swiss franc, the euro, the Japanese yen or a basket of currencies; however, currency ETFs should not be considered a long-term investment. Investors who are looking to diversify their U.S. dollar assets are generally better off investing in foreign stock or bond ETFs; however, currency ETFs can help investors to hedge their exposure to foreign currencies.

Related Readings:

An exchange-traded fund (ETF) that uses financial derivatives and debt to amplify the returns of an underlying index. Leveraged ETFs are available for most indexes, such as the Nasdaq-100 and the Dow Jones Industrial Average. These funds aim to keep a constant amount of leverage during the investment time frame, such as a 2:1 or 3:1 ratio.

A leveraged ETF does not amplify the annual returns of an index, it follows the daily changes, instead. For example, let's examine a leveraged fund with a 2:1 ratio. This means that each dollar of investor capital used is matched with an additional dollar of invested debt. If one day the underlying index returns 1%, the fund will theoretically return 2%. The 2% return is theoretical, as management fees and transaction costs diminish the full effects of leverage.

The 2:1 ratio works in the opposite direction as well. If the index drops 1%, your loss would then be 2%.

Related Readings:

With the advent of inverse ETFs, investors can easily bet against the market. Inverse ETFs are designed to move in the opposite direction of their benchmarks. For example, if the S&P 500 rises by 1%, the inverse S&P 500 ETF should drop by 1% and vice versa. There are also leveraged inverse ETFs, which are designed to provide double the opposite performance of the underlying index, so, if the S&P 500 drops by 1%, a leveraged inverse S&P 500 ETF should increase by 2%.

An inverse ETF can either use short positions of the underlying stocks or futures. ETFs that use futures contracts can have the excess cash invested in bonds, which covers the expenses of the ETF and can pay dividends to the owners.

There are a number of reasons to use inverse ETFs. For example, while speculators can easily make a bearish bet on the market, for investors who have positions that they do not want to sell because of unrealized capital gains or illiquidity, this is not so easy. In this case, they can buy an inverse ETF as a hedge.

In fact, many investors prefer to use inverse ETFs instead of selling short the index. Inverse ETFs can be purchased in tax-deferred accounts, but shorting stocks is not allowed because in theory, it exposes the investor to unlimited losses. However, the most an investor in an inverse ETF can lose is the entire value of the inverse ETF.

Related Articles
  1. Mutual Funds & ETFs

    How Mutual Fund Companies Make Money

    Read about the many different kinds of fees and sales charges mutual fund companies can use to generate revenue from those who invest in their shares.
  2. Investing Basics

    The Lipper Rating System Explained

    Take a closer look at how Lipper Inc., a subsidiary of Thomas Reuters, determines the ratings for mutual funds in its Lipper Rating System.
  3. Chart Advisor

    Bumpy Roads Ahead In Transportation

    Investors are keeping an eye on the transportation industry. We'll take a look at the trend direction and how to trade it.
  4. Investing

    How ETFs May Save You Thousands

    Being vigilant about the amount you pay and what you get for is important, but adding ETFs into the investment mix fits well with a value-seeking nature.
  5. Mutual Funds & ETFs

    3 Fixed Income ETFs in the Mining Sector

    Learn about the top three metals and mining exchange-traded funds (ETFs), and explore analyses of their characteristics and how investors can benefit from these ETFs.
  6. Mutual Funds & ETFs

    Mutual Funds Millennials Should Avoid

    Find out what kinds of mutual funds are unsuitable for millennial investors, especially when included in millennial retirement accounts.
  7. Bonds & Fixed Income

    High Yield Bond Investing 101

    Taking on high-yield bond investments requires a thorough investigation. Here are looking the fundamentals.
  8. Mutual Funds & ETFs

    Top 3 Commodities Mutual Funds

    Get information about some of the most popular and best-performing mutual funds that are focused on commodity-related investments.
  9. Chart Advisor

    Agriculture Commodities Are In The Bear's Sights

    Agriculture stocks have experienced strong moves higher over recent weeks, but chart patterns on sugar, corn and wheat are suggesting the moves could be short lived.
  10. Investing Basics

    Investing $100 a Month in Stocks for 30 Years

    Find out how you could potentially earn hundreds of thousands of dollars by just investing $100 a month in stocks during your working years.
  1. Private Equity Real Estate

    A Definition of "Private Equity Real Estate" and how it applies ...
  2. Alpha

    Alpha is used in finance to represent two things: 1. a measure ...
  3. Capitalization Rate

    The rate of return on a real estate investment property based ...
  4. Equity

    Equity is the value of an asset less the value of all liabilities ...
  5. Derivative

    A security with a price that is dependent upon or derived from ...
  6. Real Estate Investment Trust - ...

    A REIT is a type of security that invests in real estate through ...
  1. Why have mutual funds become so popular?

    Mutual funds have become an incredibly popular option for a wide variety of investors. This is primarily due to the automatic ... Read Full Answer >>
  2. Who do hedge funds lend money to?

    Many traditional lenders and banks are failing to provide loans. In their absence, hedge funds have begun to fill the gap. ... Read Full Answer >>
  3. Do mutual funds pay dividends?

    Depending on the specific assets in its portfolio, a mutual fund may generate income for shareholders in the form of capital ... Read Full Answer >>
  4. What licenses does a hedge fund manager need to have?

    A hedge fund manager does not necessarily need any specific license to operate a fund, but depending on the type of investments ... Read Full Answer >>
  5. What do hedge fund analysts do?

    A hedge fund analyst primarily provides support to a portfolio manager on how to best structure the hedge fund's investment ... Read Full Answer >>
  6. Can mutual funds invest in hedge funds?

    Mutual funds are legally allowed to invest in hedge funds. However, hedge funds and mutual funds have striking differences ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Term Deposit

    A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
  2. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  3. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  4. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  5. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  6. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!