Exchange-Traded Funds (ETFs)
ETFs come under the umbrella of Exchange-Traded Products, which includes ETNs (Exchange-Traded Notes) and ETCs (Exchange-Traded Commodities). ETNs concern themselves with debt and ETCs with single commodities. They are generally higher risk than an ETF, as they are subject to relatively increased levels of counterparty risk and non-diversification respectively.
An ETF offers a reasonably cheap and effective means of diversification and exposure to international markets. It is a passively-managed fund whose underlying assets track the performance of a market index, asset or sector, e.g. the FTSE 100, gold or infrastructure; however, it should be borne in mind that fund charges and tracking errors will mean performance is not identical. It is also possible for the chosen ETF to 'short' what it tracks, thereby making money even in a falling market.
Shares in ETFs are traded like individual shares, so the prices move throughout the day. This immediate exposure to what is being tracked as it rises and falls in value can be advantageous.
Some ETFs use derivatives and some lend portfolios to hedge funds; as a result, they incur some counterparty risk.
Leveraged ETFs magnify gains and losses. For example, a 1% rise in an index could translate into a 2% rise in the value of the ETF; a 1% loss in the index could translate into a 2% loss in the value of the ETF. This additional risk is attractive to some.
Clearly, ETFs can be utilised to great effect, but appropriate risk analysis and advice are fundamental requirements.
