Intro to ETFs & Non-traditional ETFs Flashcards
Define an Exchange-Traded Fund
Exchange-Traded Fund (ETF): is a basket of securities—such as stocks—that tracks an underlying index.
- is a marketable security
- can be bought or sold on a stock exchange
can contain all types of investments including:
- stocks
- commodities
- bonds
- mixture of investment types
most are passive, diversified, and low cost
What are the main differences between an ETF vs Mutual Fund
ETF:
- trades during the day,
- low operating expenses, no investment minimums,
- tax efficient, no sales loads
Mutual Fund:
- trades at closing (net asset value), operating expeneses may vary,
- has investment minimums,
- less tax efficient, may have sales load/management expense ratio (charged annually)
What are Traditional ETFS
+ give examples
all ETFs issued were issued were Passive, or designed to track an underlying index. The index could be listed securities (such as equities), or non-listed (such as bonds or commodities)
Ex. Fixed Income ETF and/or Commodity ETF
What are Active ETFs?
+ give example of other non-traditional ones
Active ETFs attempt to outperform an index or benchmark (excess risk-adjusted returns) by using either superior stock selection skills, asset allocation skills , factor analysis or other portfolio management strategy.
Examples:
- factor-based ETFs
- Leveraged
- Inverse/Directional
- Hedged ETFs
- Alternative Investment ETFs
What is a Leveraged ETF?
What is the warning sign associated with this ETF?
Leveraged ETFs - they seek to deliver multiples of the performance of the index or benchmark they track.
- ex. HXU - seeks daily investment results, before fees, expenses, distributions, brokerage commissions, etc.
- TSX index increases by 1% but this ETF should increase by 2%, Hence, why it’s called 2X Bull ETF
However, it can ALSO magnify losses by 2X the TSX!
Because the ETF states “daily investment results” this means if you hold the ETF for longer than a day , the return will vary, and probably not for the better if the index’s performance falls flat or even if the index rises
- they suffer from time decay!
What is an Inverse ETF?
+ what are some pros and cons ?
Inverse ETFs - seek to deliver the opposite of the performance of the index or benchmark they track.(Sometimes called “Short” or “Bear” ETFs)
Ex. ex. HXU - seeks daily investment results… that endeavour to correspond to one times (100%) the inverse (opposite) of the daily performance of the S&P/TSX 60™ Index.
Pros
+allow investors to make money when the market or the underlying index declines.
+ help investors hedge their investment portfolio.
Cons
(-) Inverse ETFs can lead to losses quickly if investors bet wrong on the market’s direction.
(-) Inverse ETFs held for more than one day can lead to losses.
(-) Higher fees exist with inverse ETFs versus traditional ETFs.
What are some Problems with Leveraged and Inverse ETFs
- Non-Traditional ETFs use swaps, futures contracts and other derivative instruments, to accomplish their objectives
- They “reset” daily, meaning that they are designed to achieve their stated objectives on only a daily basis.
- They don’t perfectly match the performance of its benchmark and this difference is called “tracking error”
- Over time, especially during market volatility or over long periods, this difference can grow, causing the ETF’s performance to deviate further from the benchmark.
- NOT MEANT FOR BUYING AND HOLDING INVESTING
Which ETFs can be purchased for buying and holding purposes?
3) Factor-based ETFs
4) Hedged ETFs
5) Alternative Investments ETFs
- these do not use leverage (nor are inverse), are designed for small investors
(of 5)
Explain Factor-based ETFs
Factors such as size, value, momentum, quality, and low volatility are at the core of “smart” or “strategic” beta strategies, and are investment characteristics that can enhance portfolios over time
Factors can also be considered anomalies (unexpected events), since they are deviations from the “efficient market hypothesis,”
Ex. LRGF – iShares Edge MSCI Multifactor USA ETF
Why LRGF?
- Efficient access to U.S. large- and mid-cap stocks, maxmizes exposure to four key factors: quality, value, size, and momentum. LRGF aims to outperform the broad market with similar risk and can serve as an alternative to traditional long-term U.S. stock holdings.
Ex. Fidelity Investments
WATCH VIDEO
Explain “Hedged” ETFs
AKA Currency Hedged ETFS
“Hedged” ETFs usually refer to Currency-Hedged ETFs (and not ETFs that hold hedge funds)
Why do investors buy Currency-Hedged ETFs?
To reduce the effects of foreign exchange risk,
How does it work?
This is done by the ETF issuer taking an offsetting short position in the foreign currency to match the total notional of the underlying portfolio, typically through the use of a forward contract.
How expensive is it for ETF buyers
Usually shows up as a slightly higher MER on the ETF
Name the 3 Alternative Investment (AI) ETFs
- Hedged Funds
- Private Equity Funds
- Real Asset Funds (commodities, real estate, infrastructure)
What are the Five Fcators of Factor ETFS?
- Size — risk return premium for investing in smaller capped companies, as they’re typically higher risk and more volatile, and investors can expect to be compensated for taking on more risk
- Value — inexpensive stocks should outperform the most expensive ones, buy stocks that are discounted from the intrinsic value
- Quality — companies with higher earrings/lower accruals, companies that financially outperform their competitors in terms of profits, therefore boosting competitive advantage, they possess strong cash flow statements and net worth statements
- Momentum — if the stocks outperforms in the medium terms then it would continue do well, trend of company doing well and outperforming
- Low volatility — stocks with a lower risk, lower volatility than the rest of the market
