ETF Basics - Types Of ETFs

Exchange traded funds are growing in popularity all the time, and they already account for a sizeable portion of the trading landscape. Many investors are discovering the advantages of ETF trading, and for beginners to ETFs, it's important to understand the types of ETFs and some of the common terms surrounding this type of investment vehicle.

Here's some basic info that will help you understand the jargon that is thrown around when people talk about ETFs. You can use this as a guide as you learn more about this unique method of trading.

Types Of ETFs

The exchange traded funds that you will find on the Australian stock market are divided into two main structures. These are:

• Actively Managed ETFs
• Indexed ETFs

Actively managed ETFs often rely on the reputation of the fund manager to outperform the underlying asset's prices on the market. These types of ETFs follow a trading strategy the fund manager sets out, which may involve anything from targeting specific types of companies or growth stocks to almost any other trading strategy you can imagine.

Actively managed ETFs are known to be more expensive in terms of fees and charges, and in times of market instability where investors are struggling to make profits, actively managed ETFs may find it difficult to provide returns. However, it all comes down to the fund manager, the underlying asset and a number of other potential variables.

Indexed ETFs (sometimes called classic ETFs) are common on the Australian stock exchange, and these types of funds aim to track an underlying index closely with minimum administrative fees. For example, you can buy an ETF that tracks the ASX 200.

Historically, these types of ETFs have often outperformed managed funds over the long term while delivering better profits to investors. However, there are always exceptions and historical performance does not offer a future guarantee.

Beta and Alpha Returns

Before long, you will come across the terms 'beta returns' and 'alpha returns' when people are discussing ETFs. Basically, beta returns refers to the overall performance of the underlying market, and alpha returns refers to excess returns above the underlying market. An indexed ETF will normally capitalise on beta returns, and an actively managed ETF with a skilled fund manager can achieve alpha returns.

This is where trading strategy comes into play, and people will argue the benefits or drawbacks of actively managed or indexed funds under different market conditions. Using ETFs can help you capitalise on beta or alpha returns depending on the fund itself and your personal trading strategy. Some strategies may use one type of fund and not the other or a combination of both.

Underlying Assets

The type of underlying assets that an ETF can allow you to invest in can be quite broad, and new funds may open up at any time as this type of trading grows in popularity. You can check the underlying assets of most ASX ETFs online.

The underlying asset for some ETFs are commodities, such as with gold ETFs, oil ETFs or agricultural ETFs. In some cases, it may be a combination of shares in relevant companies and a portion of the commodity itself among other things.

In the case of ETFs that follow market indices, the underlying asset may be a number of primary companies in the market where you are investing. The ASX 200 ETF has holdings in many top companies on the Australian stock market, and you can check the finer details with the fund itself.

You may also find ETF securities that track a portfolio based on a certain type of company. For example, you may find an ETF made up from small-cap companies, growth companies and so on. All ETFs aim to give broad exposure to the underlying asset, and indexed ETFs should track the price of the underlying asset fairly closely.

When thinking about investing on the stock market, it's important to understand all the terms, trading processes and risk factors. Consider talking to stock broker about ETFs if you're new to the stock market.