1. Exchange-Traded Funds: Introduction
  2. Exchange-Traded Funds: Background
  3. Exchange-Traded Funds: Features
  4. Exchange-Traded Funds: Biggest ETFs and ETF Providers
  5. Exchange-Traded Funds: Active Vs. Passive Investing
  6. Exchange-Traded Funds: Index Funds Vs. ETFs
  7. Exchange-Traded Funds: Equity ETFs
  8. Exchange-Traded Funds: Fixed-Income and Asset-Allocation ETFs
  9. Exchange-Traded Funds: ETF Alternative Investments
  10. Exchange-Traded Funds: ETF Investment Strategies
  11. Exchange-Traded Funds: Best Practices for Trading ETFs
  12. Exchange-Traded Funds: Conclusion

As a core asset class for investment portfolios, investors should have a good understanding of the various types of equity ETFs available. We present below a brief analysis of the various kinds of equity ETFs.

Equity ETFs broadly fall into one of three categories:

Broad market ETFs – Broad market ETFs provide exposure to all the sectors in a country and typically track its benchmark equity index or indices. Using an ETF that tracks the index enables the investor to receive full market exposure at a fraction of the cost, compared with buying the hundreds of securities that constitute the index.

Sector ETFs – These ETFs provide exposure to a specific sector. They are useful when trying to build a concentrated portfolio of specific sectors or adjusting the weights of a portfolio to overweight some sectors and underweight others. (Related: An Introduction To Sector ETFs)

Smart Beta ETFs – Smart Beta or Factor-based ETFs use rules-based strategies that set out specific criteria, which securities must meet to be included in the ETF. These ETFs include dividend-focused, low-volatility, high quality and equal-weighted TFs.  

A wide range of equity ETFs are available in the U.S., the world’s biggest ETF market by far, with total AUM of $3.3 trillion.

Broad-based U.S. ETFs

U.S. total market and broad-based ETFs are designed to give an investor exposure to the entire U.S. equity market. Although indexes like the Dow Jones Industrial Average and S&P 500 extremely popular and widely used, they represent a subset of the overall market and have a large-cap bias. Investors who wish to invest in small-cap and mid-cap stocks would therefore have to use ETFs that track other indices.

Total market and broad market ETFs tend to be inexpensive, with low expense ratios and narrow bid-ask spreads. Their market breadth also means that they are less volatile than more focused equity ETFs.

Popular broad-based U.S. equity ETFs include –

  • iShares Russell 3000 ETF (IWV)
  • Schwab U.S. Broad market ETF (SCHB)

All-World and All-World ex-U.S.

An investor can now achieve global equity diversification with a single ETF. All-world ETFs provide exposure to most of the major developed and emerging markets. Investors can choose between ETFs that represent the whole world including the U.S. (all-world) or excluding the U.S. (all-world ex-U.S.). Since the U.S. market accounts for a very substantial portion of global equity capitalization, U.S. investors who already own U.S. equities would be better served by all-world ex-U.S. ETFs. Examples of these ETFs include –

  • Vanguard Total World Stock ETF (VT)
  • Vanguard Total International Stock ETF (VXUS)
  • iShares MSCI ACWI (All Country World Index) ETF (ACWI)

Developed versus emerging markets

Since stocks in emerging markets have characteristics that are quite different from stocks in developed markets, from a portfolio construction perspective, it may be worthwhile to consider these equities in the following three distinct investment categories (with examples shown in parentheses):

  • U.S. equities (SPY or VTI)
  • Developed countries ex-U.S. (iShares MSCI EAFE ETF, EFA)
  • Emerging markets (Vanguard FTSE Emerging Markets ETF, VWO)

Sector ETFs

As noted earlier, these ETFs provide exposure to a specific industrial sector. Sector ETFs tend to be more expensive than broad market ETFs, and are generally more volatile as well. Popular U.S. sector ETFs include –

  • Vanguard REIT ETF (VNQ): this ETF tracks the MSCI U.S. REIT Index, a gauge of real estate stock, and offers high levels of investment income.
  • Financial Select Sector SPDR Fund (XLF): this ETF provides exposure to an index of the biggest U.S. financial companies, including Berkshire Hathaway, JP Morgan, Bank of America, and Wells Fargo.

Market Capitalization ETFs

One of the most basic ways to categorize stocks is on the basis of their market capitalization. On this basis, stocks can be classified into large-cap, mid-cap and small-cap, with each category having its own unique attributes. For example, small-cap stocks have historically grown faster than large-cap stocks, but have also been accompanied by significantly higher volatility. Examples of market-cap ETFs include:

  • iShares Core S&P Mid-Cap ETF (IJH)
  • iShares Russell 2000 ETF (IWM)
  • iShares Core S&P Small-Cap ETF (IJR)

Growth & Value ETFs

In addition to their market cap, stocks can also be classified as value stocks or growth stocks. Value stocks typically have low valuations, such as a low P/E ratio, low price-to-book-value, and high dividend yield. Growth stocks generally trade at higher valuations because they are expected to grow earnings, book value and dividends at a rapid pace in future. Examples of growth and value ETFs include:

  • iShares Russell 1000 Growth ETF (IWF)
  • Vanguard Value ETF (VTV)
  • Vanguard Growth ETF (VUG)
  • iShares S&P 500 Growth ETF (IVW)

Leveraged ETFs

Leveraged ETFs offer exposure to broad U.S. market indices but have greater volatility because of their leverage. Thus, if the S&P 500 rises by 1% on a given day, the ProShares Ultra S&P 500 ETF – which seeks to provide daily investment results that correspond to two times the daily performance of the S&P 500 – will rise by 2%. Conversely, if the S&P 500 falls by 1% on a given day, the ETF will decline by 2%. Leveraged ETFs are used by active traders to capitalize on short-term market movements, and can also be used to increase exposure to an index without having to borrow additional funds. They tend to have significantly higher expense ratios than standard index ETFs. An important point to note with regard to leveraged ETFs is that due to the compounding of daily returns, returns over periods other than one day will likely differ not just in magnitude but also in direction from the target return for the same period. Examples of leveraged ETFs include:

  • ProShares Ultra Dow30 ETF (DDM)
  • ProShares Ultra S&P 500 ETF (SSO)

Quantitative ETFs

Quantitatively based ETFs use enhanced indexing to offer investors the potential to outperform a benchmark index. Quantitative indexing uses predefined rules to rank stocks based on a number of different characteristics, including fundamental and technical factors. The top-ranked stocks out of this universe are then selected to form an index. Such ETFs are generally rebalanced quarterly, as a result of which they have higher stock turnover, potentially higher trading costs and lower tax efficiency. Examples of these ETFs include:

  • PowerShares Dynamic Market Portfolio (PWC)
  • First Trust Large Cap Core AlphaDEX Fund (FEX)

Smart Beta ETFs

Smart Beta ETFS have proved to be very popular in recent years. Globally, Smart Beta ETF assets are projected to grow from $400 billion in 2016 to $1 trillion by 2020 and $2.4 trillion by 2025, according to an iShares forecast. (Related: Biggest Smart Beta ETFs) Smart Beta encompasses a wide range of ETFs; examples of some U.S. ones include:

  • Guggenheim S&P 500 Equal Weight ETF (RSP) – Launched in April 2003, this pioneering Smart Beta ETF tracks the S&P 500 Equal Weight Index, which is a better indicator of market breadth than the market cap-weighted S&P 500 index.
  • iShares Edge MSCI Min Vol USA ETF (USMV)
  • Vanguard Dividend Appreciation ETF (VIG)

 


Exchange-Traded Funds: Fixed-Income and Asset-Allocation ETFs
Related Articles
  1. Tech

    How To Pick The Best ETF

    Of the hundreds of exchange-traded funds on the market, some are bound to fail. Learn how to pick the best of the bunch.
  2. Investing

    4 Ways to Evaluate ETFs Before Buying

    Learn four areas in which to evaluate an ETF investment to be sure that the investor has a clear understanding of the security being purchased.
  3. Investing

    4 Trends in the ETF Market to Date in 2016 (SPY)

    Learn about four emerging ETF trends in 2016, including what they signal about broader trends in investing and the financial services industry.
  4. Investing

    Exchange-Traded Funds: Diversified and Affordable

    Exchange traded funds offer many benefits when compared to stocks and index mutual funds.
  5. Investing

    How Big Is the Global ETF Market? (BLK, STT)

    Discover why ETFs are growing much faster than mutual funds, and why some experts predict the ETF market will double by 2020.
  6. Investing

    The Advantages of ETFs Compared to Index Funds

    With the ongoing ETF boom, ETFs gain more variety and increased competition in the market leads to further investors' advantages compared to index funds.
  7. Investing

    Avoid ETFs With These Traits

    Deciding which ETFs to avoid can be as important an investment decision as deciding in which ones to invest.
  8. Investing

    The Outlook for ETF Investors in 2017

    Here's why the popularity of ETFs shows no sign of slowing down in 2017.
  9. Financial Advisor

    What Your Clients Must Know About ETFs

    Like any investment, ETFs come with some fine print. Here is what advisors should reveal to their clients about these hugely popular products.
Frequently Asked Questions
  1. What Was the First Company to Issue Stock?

    The Dutch East India Co. held an IPO in 1602, making it the first company to issue stock.
  2. When Does a Corporation Decide to Refinance Debt?

    Favorable market conditions or the strengthening of a credit rating may lead to refinancing.
  3. What Is an Odd-Lot Buyback?

    Odd-lot buybacks involve lots of less than 100 shares. Learn how companies get these shares back.
  4. Can I buy a house directly from Fannie Mae (FNMA)?

    Yes, Fannie Mae does sell properties it's foreclosed on; each property is sold in "as is" condition.
Trading Center