By Aniket Bose. Edited by Arjun Chandrasekar
An exchange-traded fund is basically a type of investment fund and an exchange-traded product. For example, they are mostly traded during stock exchanges. The way it works is the fund provider owns the underlying assets, then he designs a fund to track the performance of the assets and later sells the shares in that fund to investors.
Investors in an exchange-traded fund that buy shares of these funds get lump divided payments, or reinvestments, for the stocks that make up the index.
There are six common types of exchange traded funds: Equity, Fixed-Income, Commodity, Currency, Real Estate, and Specialty. Let’s explore each one in detail.
These funds are invested in stocks, which are also called equity securities. They can be contrasted with bond funds and money funds. These funds can also be managed actively or passively. Equity funds are principally categorized according to the company size, the investment style of the holdings in the portfolio and geography.
These funds are invested in bonds, which may also include government bonds, corporate bonds, mortgage bonds, municipal bonds, zero-coupon bonds, or high-yield bonds. The funds buy investments that pay a fixed rate of return on these bonds. They aim to have money coming into the fund on a regular basis, mostly through interest that the fund earns.
These funds are invested in raw materials or primary agricultural products, which are known as commodities, hence the name of commodity funds. The investments go into the stocks of mining companies and in the actual products as well. Commodity investing is beneficial when the market is not doing as well because commodity funds may perform well despite when the overall commodity prices are not doing so well. Investing in commodities is actually less risky than investing in the broad stock market by 14%, measured by the standard deviation of annual returns. A commodity is essentially a basic good used in commerce that is interchangeable with other goods of the same type. Some classic examples of commodities include grains, gold, beef, oil, and natural gas.
These funds are financial products built with the goal of providing investment exposure to foregin exchange currencies. They are mostly passively managed with underlying currency holdings in a single country or basket of countries. Currency funds typically have a low interest rate in relation to the high asset currency. Investors borry currency funds and take advantage of currency assets, which has a higher interest rate compared to currency funds.
Currency funds come in two different varieties: single-currency funds and multi currency funds.
Many of these funds are invested in high-quality money-market instruments denominated in the target currencies. Some of these funds invest in currency forward contracts and currency swaps, which can potentially make things more complicated for investors.
Real Estate Funds
These funds are a type of mutual fund that invest in securities offered by public real estate companies, including REITs. REITs stands for real estate investment trust that owns many types of commercial real estates ranging from apartments to shopping centers.
REITs pay out regular dividends to their investors, while real estate funds provide their value through their appreciation. Real estate funds are better for investors that stay more long-term because these funds provide dividend income and the potential capital appreciation which is highly beneficial for long term investors. Depending on the investor’s investment strategy, real estate funds can be a much more diversified investment vehicle compared to a REITs investment.
These funds are also a type of mutual fund like real estate funds, however this fund focuses their equity investing within a specific industry or sector of the economy. Some specialty funds cover broad sectors and others direct their investments on an industry group within a sector. Before investing in specialty funds, investors should carefully analyze the past year’s performance of the fund then make a decision wisely. The reason being because specialty funds are very high-risk, so it basically ends up being boom or bust. There are three different types of speciality funds: sectoral funds, thematic funds, and regional funds.
Sectoral funds typically invest in the technology, banking, and real estate industries. Due to the reason for these funds specifically targeting one segment of the economy, they tend to have a high volatility in terms of returns. These funds are suggested to those aggressive investors that are interested in taking high risks. Investors will choose sectoral funds when they expect a particular industry to outperform the overall capital market.
Thematic funds invest their assets in a theme-oriented pattern that may comprise multiple related sectors. For example, MNC, energy, consumption-oriented funds. In order for a fund to be classified as a thematic fund, it must invest at least 80% of its assets in the sectors related to a particular theme. The rest of the assets can then be allocated to other equity and debt.
Regional funds primarily invest in a specific geographical area across the globe. They invest in certain continents, countries, states where there is a good chance of high economic growth and facilitative business environment in the near future. These funds are also called offshore funds which are essentially mutual fund schemes, however they invest their assets in the international market instead. Some regional funds strategise as sector funds and invest in a particular industry in a particular region, kind of like sectoral funds. Returns from this kind of investment will depend on how the industry performs in that particular region.