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. Investing

    2 Common Ways to Misuse Target Date Funds

    The world of asset classes is just as complicated as taking vitamins. How much should you take of small caps? Intermediate bonds? Emerging market stocks?
  4. Mutual Funds & ETFs

    What Target-Date Funds Can Teach About Investing

    Target-date funds are a popular way to invest for retirement. Here's what they can teach the novice investor.
  5. Economics

    The Effect of Fed Fund Rate Hikes on Gold

    Explore the historical relationship between interest rate increases and the price of gold, and consider what effect a fed funds rate hike might have on gold.
  6. Investing

    The ABCs of Bond ETF Distributions

    How do bond exchange traded fund (ETF) distributions work? It’s a question I get a lot. First, let’s explain what we mean by distributions.
  7. Professionals

    Illiquid Real Estate: Correlation Pros and Cons

    Stock and bond markets are moving more closely in tandem with each other. Is illiquid real estate the vaccine for this correlation?
  8. Mutual Funds & ETFs

    4 Mutual Funds Warren Buffet Would Buy

    Learn about four mutual funds Warren Buffett would invest and recommend to his trustee, and discover detailed analysis of these mutual funds.
  9. Mutual Funds & ETFs

    Passively Managed Vs. Actively Managed Mutual Funds: Which is Better?

    Learn about the differences between actively and passively managed mutual funds, and for which types of investors each management style is best suited.
  10. Professionals

    How to Navigate Taxable Mutual Fund Distributions

    It's almost time for year-end capital gains distributions for mutual funds. Here's how to monitor them and minimize their tax impact.
  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. How do hedge funds use equity options?

    With the growth in the size and number of hedge funds over the past decade, the interest in how these funds go about generating ... Read Full Answer >>
  2. Can mutual funds only hold stocks?

    There are some types of mutual funds, called stock funds or equity funds, which hold only stocks. However, there are a number ... Read Full Answer >>
  3. How do mutual funds compound interest?

    The magic of compound interest can be summed up as the concept of interest making interest. On the other hand, simple interest ... Read Full Answer >>
  4. How do I read and analyze an income statement?

    The income statement, also known as the profit and loss (P&L) statement, is the financial statement that depicts the ... Read Full Answer >>
  5. Do mutual funds pay interest?

    Some mutual funds pay interest, though it depends on the types of assets held in the funds' portfolios. Specifically, bond ... Read Full Answer >>
  6. 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 >>

You May Also Like

Hot Definitions
  1. Real Estate Investment Trust - REIT

    A REIT is a type of security that invests in real estate through property or mortgages and often trades on major exchanges ...
  2. Section 1231 Property

    A tax term relating to depreciable business property that has been held for over a year. Section 1231 property includes buildings, ...
  3. Term Deposit

    A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
  4. 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. ...
  5. Capitalization Rate

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

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