Exchange Traded Funds (ETFs)

Exchange-Traded Funds (ETFs): Passive Investing Strategy

How an ETF Works

ETFs can be thought of as marketable securities that track the price of assets within a basket of grouped assets, which enables investing in the broader market, sector, region, or asset class.

The value of an ETF is directly a function of the price performance of the collection of assets contained within the index.

The goal of ETFs is not to outperform the broader market nor the underlying index – although it is possible for certain ETFs to “beat the market” – but rather, most ETFs just attempt to replicate the performance of the assets being tracked.

Common Types of ETFs and Market Participants

The various types of ETFs include the following:

• Long ETFs: “Long Positions” Tracking Underlying Stock Indices (S&P 500, Dow, Nasdaq)
• Inverse ETFs: “Short Positions” on Underlying Stock Indices
• Industry/Sector ETFs: Portfolio of Stocks Operating in a Specific Industry or Sector (e.g. Technology, Healthcare, Oil & Gas, Energy)
• Commodity, Precious Metal & Currency ETFs: Invest in Certain Commodities, Precious Metals (e.g. Gold), and Foreign Currency Fluctuations
• Country/Region ETFs: Portfolio of Shares of Public Companies in Specific Country/Region
• Leveraged ETFs: Utilize “Borrowed Funds” to Amplify Portfolio Returns (and Risk)
• Thematic ETFs: Portfolio of Disruptive Stocks with Long-Term Societal Tailwinds (e.g. Clean Energy, Robotics, Electric Vehicles, Cloud Computing)

ETF Investor Benefits: Why Invest in ETFs?

There are numerous benefits to ETF investors:

• Diversification: Reduced Portfolio Risk and Concentrated Exposure
• Higher Liquidity: Actively Traded with High Volume in the Open Market (e.g. Market Indices)
• Lower Fees: Passive Management ➝ Reduced Management and Administrative Fees
• Convenience: Alternative Option for Long-Term, Passive Investors
• Transparency: Index-Based ETFs Publish Lists of Holdings Daily

ETFs vs. Mutual Funds

An ETF is structured similarly to a mutual fund as both funds contain a mixture of assets and represent methods for investors to diversify.

However, an ETF is listed on a public exchange and can be traded on the secondary market similar to stocks, unlike mutual funds.

For mutual funds, trades are executed only once per day after the markets close.

With that said, ETFs have higher liquidity because they trade continuously when the market is open.

Another noteworthy difference between an ETF and a mutual fund is that mutual funds are actively managed by a fund manager that adjusts the holdings (i.e. buy and sell assets) as appropriate to increase investor profits.

On the other hand, ETFs are passively managed since they track a specific index for the most part – although there are exceptions as we’ll discuss later.

Because ETFs are tied to a particular index, their performance is subject to the market and investor sentiment as opposed to the investment acumen and discretionary asset allocation decisions of an active manager.

Top ETF Examples (S&P 500, Russell 2000, Nasdaq)

In the U.S., examples of ETFs with large followings include:

S&P 500 Index

• SPDR S&P 500 ETF Trust (SPY)
• Vanguard’s S&P 500 ETF (VOO)
• iShares Core S&P 500 ETF (IVV)

Russell 2000 Index

• iShares Russell 2000 ETF (IWN)
• Vanguard’s Russell 2000 ETF (VTWO)

Nasdaq

• Invesco QQQ (QQQ)
• Invesco Nasdaq 100 ETF (QQQM)

Ark Invest ETF – Cathie Wood (Disruptive Innovation)

One of the more mainstream thematic ETFs has been Ark Invest’s offerings, which rose in popularity after placing considerable bets on innovative technologies such as FinTech, AI, and 3D printing.

For instance, Ark Invest’s flagship Disruptive Innovation ETF has the following investment focus:

^{Disruptive Innovation ETF Investment Focus (Source: Ark Invest)}

Examples of other specialty ETF products by Ark Invest include:

• Next Generation Internet
• Genomic Revolution
• Autonomous Tech & Robotics
• Fintech Innovation
• Mobility-as-a-Service
• Space Exploration
• ARK Early-Stage Disruptors
• 3D Printing
• ARK Transparency

Unlike other ETFs that track the broader market indices, these thematic ETFs blend passive investing with active management because each fund targets specific trends with the potential to disrupt entire industries.

However, the downside to thematic ETFs comprised of high-growth equities is that despite the possibility for higher returns – the portfolio is less diversified and more susceptible to volatility (and losses) – as confirmed by the underperformance of Ark ETFs in 2021.