Classification of ETFs

We have understood the concept and advantages of ETF funds. ETFs not only save you time but also help you save money. In this lesson, we will discuss the four major types of ETFs, giving you a clearer understanding of this diverse family.

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

In the US stock market, the three most familiar indices are the Dow Jones Industrial Average, the S&P 500 Index, and the Nasdaq Index. If you are particularly bullish on one of these indices and want to benefit from its rise, what should you do?

It's simple, you just need to find the ETF that tracks this index. For example, ETF tracking the Dow Jones Index: DIA; ETF tracking the Nasdaq Index: QQQ; ETF tracking the S&P 500 Index: SPY.

Please note that there may be more than one ETF tracking a specific index! Let's take the S&P 500 Index as an example. Currently, there are many ETFs tracking the S&P 500 Index in the market, with the most well-known being SPY, IVV, and VOO.

What are the differences between these three ETFs tracking the S&P 500 Index? The answer is that there is no difference, only the issuer of the ETF is different.

The issuer of SPY is SPDR, the third-largest global asset management company, an investment department under the Dow Jones Group. The issuers of IVV and VOO are globally renowned Vanguard Group and the world's largest asset management company BlackRock, respectively.

By superimposing the trends of these top three ETFs on the Tiger International app, we can see that over the past 8 years, their trends have been very similar, with very small tracking errors.

Therefore, index ETFs are also known as passive ETFs, mainly aimed at tracking the trend of the index to achieve the effect of replicating index returns.

(Image source: Tiger International PC version)

Compared to ETFs tracking the index, there is another type of ETF that is selected and managed by fund managers themselves, known as active ETFs.

Since fund managers need to put in more work, the management fee for active ETFs is generally higher than passive ETFs. However, the performance of active ETFs is not necessarily better than passive ETFs.

As shown in the figure below, according to the data from the international authoritative rating agency Morningstar, in the past decade, the annualized excess returns of most active ETFs have been mostly below zero, with a maximum of -0.5% for active funds.

(Source: Morningstar website, data as of December 31, 2019, for reference only, historical performance does not represent any prediction of future returns or investment advice)

Divided into major asset classes, ETFs can be classified as stock ETFs, bond ETFs, and alternative asset ETFs.

We can think of the stock market as a fruit market, where you can freely buy any kind of fruit. Of course, you can also buy a basket of pre-packaged fruits. In the real financial market, you can understand the fruit market as the stock market and the fruits as stocks, so the fruit basket is the stock ETF.

As the "fruit basket" of the financial market, each basket of stock ETFs is pre-packaged with stocks of different types and weights, and then sold to you in the form of fund shares.

Different ETF stocks have different holdings, so before trading ETF stocks, make sure to determine the components of the ETF and see if it meets your purchase expectations.

Bond ETFs, also known as bond exchange-traded funds, are packaged investment tools for bonds that track bond indexes and attempt to replicate their returns as exchange-traded securities investment funds.
Although bond ETFs only contain bonds, they trade on the exchange like stocks and have characteristics similar to equity securities. Compared to regular bonds, bond ETFs have the following advantages:

(1) Low risk;Similar to stock ETFs, bond ETFs allocate a wide variety of bonds, providing a significant quantitative advantage compared to individual bonds. Bond ETFs have lower sensitivity to single unexpected events, resulting in relatively smaller non-systemic risk compared to individual bonds.

(2) Simple trading;Through ETFs, investors can buy or sell on trading days, eliminating the complex procedures of bond trading in the OTC market. Trading can be done with just a mobile phone; investors only need to observe the performance of the target index to understand the performance of bond ETFs.

(3) Stable returns;Historical data shows that the majority of active fund managers find it difficult to outperform the market over the long term. Investing in bond ETFs reduces the uncertain risk of lower-than-expected returns due to poor fund management, providing relatively long-term, stable, and predictable returns.

Let's start with what alternative assets are. The scope of alternative assets is very wide, including gold and currency, commodity equities, real estate, private equity, infrastructure, and more.

Among them, gold ETF is a common tradable instrument in the market. The vast majority of its fund symbols are based on gold assets, closely tracking the price of gold, and are open-ended funds listed on stock exchanges.

Similarly, commodity ETFs, real estate ETFs, and other alternative asset ETFs are all investment targets corresponding to the assets. Therefore, alternative asset ETFs are open-ended funds that track the trends of alternative assets.

The advantage of alternative assets is that investors can participate in the trading of expensive assets such as gold, crude oil, real estate, etc. with a very low threshold, and the liquidity of funds is much stronger than that of trading physical assets.

Second, classified by industry themes
Classified by industry or theme, ETFs can be divided into industry ETFs and thematic ETFs.

What is an industry ETF? As I mentioned in the previous "Introduction to US Stock Earnings Reports" course: In the United States, the common industry classification standard is mainly the GICS industry classification. According to this classification standard, US stocks can be divided into 11 primary industries, namely energy, raw materials, industrials, consumer discretionary, consumer staples, healthcare, finance, information technology, communication, utilities, and real estate.

If you have a strong belief in a particular industry and want to participate in investments in that industry, what should you do? The answer is to buy the corresponding industry ETF.

In the US, all 11 major sectors have ETF coverage, and below these sectors, we can actually find corresponding passive ETFs for investment in the sub-industries. Here, taking the medical health sector as an example, its three-level sub-industries, medical equipment, medical services, pharmaceuticals, biotechnology, and life sciences, also have corresponding ETFs for tracking.

(Source: Bloomberg, MSCI)

After understanding industry ETFs, let's take a look at theme ETFs.

Many investors may find GICS industry segmentation too rigid, not being able to distinguish which sub-industry familiar companies belong to, or may have a bullish view on a specific investment theme or concept rather than a specific sub-industry. In this case, some theme ETFs are a good choice.

For instance, in the rapidly developing cloud computing industry, there is a First Trust ETF, SKYY, which tracks companies like Amazon, Alibaba, Microsoft, and Google, which are giants in the cloud computing business, as well as newcomers like Kingsoft Cloud and MongoDB.

For investors with a liking for clean energy, they can find the iShares Global Clean Energy ETF, ICLN, which tracks the s&p global clean energy index.

(Source: Morningstar website, data as of 11/30/2020, data is for reference only and does not represent any predictions or investment advice on future returns)

Choosing industries and sectors, and purchasing the best-performing companies in the entire industry through ETFs, helps enrich the investment portfolio and diversify investment risks.