What are the different types of ETFs?

While there are over 1,800 ETFs available in Europe today, most of their assets are invested in traditional index-based ETFs. The goal of an index ETF is to track the performance of a specific market benchmark as closely as possible. Examples of well-known benchmarks are the FTSE 100, the FTSE Developed Europe Index and the S&P 500. That's why you may hear it referred to as being “passively managed” investments.

Index based ETFs are available in an increasing number of styles and asset classes, including regional and global equity and fixed income markets. They range from products that invest in the widest coverage of the markets, to those that invest in specific industries. Some of the styles of ETFs cover the growth and value spectrum. Others track certain market capitalisation ranges.

International ETFs cover the global markets and offer exposure to a single country or a region of the world. Finally, fixed income ETFs cover a variety of duration, credit quality and maturity ranges. And there are other types of ETFs that thanks to a recent surge have led to a significant level of product innovation and proliferation. The latest global industry offerings include ETFs that go beyond the traditional index based approach.

Let's look at a few examples, starting with actively managed ETFs. With these, rather than aiming to closely track a market index, a portfolio manager actively manages the assets within the ETF to achieve a particular investment objective. Actively managed ETFs represent a small but growing portion of the overall industry. There are also commodity and currency ETFs, which invest in the commodities and currency markets, either through physical assets or through the futures markets.

These provide investors with exposure to alternative investments such as agricultural products, precious metals, energy and currencies. At the riskier end of the ETF universe there are both inverse and leveraged ETFs. These are types of synthetic ETFs, which are unique and involve additional risks and considerations not present in traditional ETF products. Inverse ETFs attempt to deliver the opposite or inverse returns of the benchmarks they track.

An inverse ETF is expected to deliver a positive return on the day when its index goes down and a negative return when the index goes up. Leveraged ETFs attempt to deliver multiples of the returns of the benchmarks they track. Such an ETF might be designed to return two or three times the value of the daily benchmark increase, or conversely, two or three times the benchmark’s decline.

It’s important to remember that most inverse and leveraged ETFs are designed to achieve their objectives daily. When held for more than a day these ETFs can produce returns that differ from the inverse or leverage multiple. Inverse and leveraged ETFs are riskier than the alternatives that don't use leverage and are generally appropriate for an extremely narrow set of investment objectives, such as short term market timing or hedging purposes.

And they are not intended for long term buy and hold investments.