ETF classification

We've learned the concept and benefits of ETF funds. ETFs not only save trouble, they can also help you save money. In this lesson, we'll talk about the four types of ETFs to give you a better understanding of the ETF family.

First, according to the management method, ETFs can be divided into index ETFs and active ETFs.

Among US stocks, the three most familiar indices are the Dow Jones Index, the S&P 500 Index, and the Nasdaq Index. If you are particularly optimistic about one of these indices and want to reap the benefits of its rise, what should you do?

It's easy, just find an ETF that tracks this index. For example, ETF: DIA that tracks the Dow Jones index; ETF: QQQ that tracks the NASDAQ index; ETF: SPY that tracks the S&P 500 index.

Note here that there may be more than one ETF that tracks a certain index! Let's take the S&P 500 index as an example. Currently, there are many ETFs on the market that track the S&P 500 index. The three most widely known are SPY, IVV, and VOO.

What are the differences between these three ETFs that track the S&P 500 index? The answer is, there's no difference; it's just that the issuer issuing the ETF is different.

The issuer that issued SPY is SPDR, the third-largest asset management company in the world, and the investment division of State Street Group. The issuers that issue IVV and VOO are the world-renowned Vanguard Group (Vanguard) and BlackRock (BlackRock), the world's largest asset management company.

We can see by fitting the trends of these three major ETFs together on the Tiger International app. Over the past 8 years, their trends have been basically the same, and the tracking error is very small.

Therefore, index ETFs are also called passive ETFs. The main purpose is to track the trend of the index and achieve the effect of replicating index earnings.

(Image source: Tiger International PC version)

Compared to ETFs that track indices, there is another type of ETF where the fund manager selects and manages its own shares and is called an active ETF.

Since fund managers require more labor, the management fee for active ETFs is generally higher than for passive ETFs. However, active ETFs don't necessarily perform better than passive ETFs.

In the chart below, according to data from Morningstar, an authoritative international rating agency, the majority of active ETFs have annualized excess returns below 0 in the past ten years, and active funds with excess returns of -0.5% are the most common.

(Source: Morningstar Network. The data deadline is December 31, 2019 and is for reference only. Historical performance does not represent any predictions or investment suggestions for future earnings)

According to the classification of major asset classes, ETFs can be divided into stock ETFs, bond ETFs, and alternative asset ETFs.

We can think of the stock market as a fruit market; you are free to buy any kind of fruit. Of course, you can also buy fruit baskets with packed fruit. In a real financial market, the fruit market can be understood as a stock market, and fruit is understood as a stock, then the fruit basket is a stock ETF.

As the “fruit basket” of the financial market, each basket of stock ETFs packages stocks of varying types and weights, and then sells them to you in the form of fund shares.

Different ETF stocks have different positions, so before trading a stock ETF, you must determine the ETF's constituent stocks to see if they meet your purchasing expectations.

Bond ETFs are also known as bond-type exchange funds. It is a bundled investment tool for bonds. It is a transactional securities investment fund that tracks a bond-like index and tries to replicate its yield.
Although bond ETFs only include bonds, they are traded on exchanges like stocks and have the characteristics of some equity securities. Compared to ordinary bonds, bond ETFs have the following advantages:

(1) Low risk;Similar to stock ETFs, bond ETFs allocate a wide variety of bonds, which have a clear quantitative advantage over single bonds. Bond ETFs are less sensitive to single emergencies. Compared with single bonds, non-systemic risks are relatively small.

(2) Simple transactions;Through ETFs, investors can buy or sell at any time during the trading day, eliminating the complicated procedures of bond trading in the OTC market; they only need a mobile phone to trade; investors only need to observe the performance of target indices to understand the performance of bond ETFs.

(3) Stable earnings;Historical data shows that it is difficult for the vast majority of active fund managers to win the market in the long term. Investment bond ETFs reduce the uncertain risk of lower returns than expected due to poor management by fund managers, and provide relatively long-term, stable, and easy-to-predict returns.

Let's first talk about what alternative assets are. The range of alternative assets is very broad, including gold and currency, commodities, real estate, private equity, infrastructure, etc.

Among them, gold ETFs are a common trading type in the market. The vast majority of its funds target open funds that target gold assets, closely track the price of gold, and are listed on the stock exchange.

Similarly, commodity ETFs, real estate ETFs, etc. all use corresponding assets as investment targets, so alternative asset ETFs are open-ended funds that track the trend of alternative assets.

The advantage of alternative assets is that investors can participate in expensive gold, crude oil, real estate, etc. transactions with a very low threshold, and the liquidity of capital is far better than trading physical assets.

II. Classification according to industry themes
According to industry or subject classification, ETFs can be divided into industry ETFs and themed ETFs.

What is an industry ETF? I also mentioned in the previous “Introduction to US Stock Financial Reporting Course”: In the US, common industry classification standards are mainly GICS industry classification. According to this classification standard, US stocks can be divided into 11 tier-1 industries, namely energy, raw materials, industry, optional consumption, primary consumption, healthcare, finance, information technology, communications, utilities, and real estate.

If you are particularly optimistic about an industry and want to participate in investment in this industry, what should you do? The answer is to buy ETFs in the corresponding industry.

The 11 major US stock sectors are all covered by ETFs, and in the industry segments below the sector, we can actually find corresponding passive ETFs to invest in. Here, I'll take the healthcare sector as an example. Its third-level sub-industries healthcare equipment, healthcare services, pharmaceuticals, biotechnology, and life sciences also have corresponding ETF tracking.

(Source: Bloomberg, MSCI)

Now that we know about industry ETFs, let's take a look at themed ETFs.

Many investors may think that GICS's industry segmentation is a bit too structured. They don't know which segment the company they are familiar with belongs to, or that they are not optimistic about a certain industry segment, but a certain investment theme or concept, then some themed ETFs are a good choice.

For example, the cloud computing industry, which has achieved breakthrough development, is First Trust's ETF SKYY tracking. Its holdings include giants of a certain scale cloud computing business such as Amazon, Alibaba, Microsoft, and Google, as well as upstarts such as Jinshan Cloud and MongoDB.

Investors with a soft spot for clean energy can also find ICLN, a global clean energy ETF issued by iShares, which tracks the S&P Global Clean Energy Index.

(Source: Morning Star Network, data as of 2020/11/30. The data is for reference only and does not represent any predictions or investment suggestions for future earnings)

Selecting industries and sectors and purchasing the best performing companies in the entire industry through ETFs can help enrich investment portfolios and diversify investment risks.