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An ETF fund (exchange traded fund) is an investment vehicle that tracks an index, a commodity or a basket of assets. ETF funds are traded like regular stocks in a stock exchange. The indices that are tracked by ETF funds include the Dow Jones Industrial Average and Standard & Poor’s 500.
Types of ETF Funds
Given below are the major types of ETF funds:
Index Funds: Most ETFs are index funds that can hold securities which replicate the performance of a stock market index. These funds can also track the performance of the index by holding a representative sample of the securities.
Currency ETFs: Such ETFs may be tracking a single currency or a basket of currencies. One of the best examples of a currency ETF is the Euro Currency Trust, which is traded on the New York Stock Exchange. Deutsche Bank’s EONIA Total Return Index is another important currency ETF tracking the euro.
Actively Managed ETFs: These ETFs were launched in March 2008. They are managed more actively than the regular ETFs.
Hedge Fund ETFs: These ETFs have only recently entered the market and track hedge funds. Each of these ETFs follows a particular hedge fund strategy.
Leveraged ETFs: Such exchange-traded funds aim at achieving returns that are highly sensitive to market movements. Leveraged ETFs are typically designated as bull or bear funds.
How is an ETF Fund Traded?
Exchange traded funds are pooled funds. ETF funds are similar to the traditional mutual funds in many respects. The trading of an ETF fund is carried out in large blocks.
Only the so-called institutional investors can directly redeem or obtain ETFs. These institutional investors, also known as the authorized participants, create the secondary market for ETFs. Other individuals, who do not fall under the category of institutional investors, can trade ETFs in the secondary market through brokerages.
Benefits and Risks of ETF Funds
ETFs allow investors to easily diversify their investment portfolio. By purchasing ETFs, one can benefit from professional advice without having to pay an exorbitant fee for it. Investors can also benefit from selling short and buying on margin. The profitability of ETF funds depends upon the efficiency of the arbitrage mechanism. ETFs that track unknown indices are highly risky.