What Is An ETF_1024 x 770

What is an ETF?

ETFs

Saxo Group

Summary:  With an exchange-traded fund (ETF), you can get a broad exposure to a basket of financial assets through a single instrument. And, with ETFs offering short-selling and leverage opportunities, you can stay competitive in both bear and low volatility environments. In this article, we look closer at three different ETF types and how you can use them in your investment strategy.


An ETF is an instrument traded like an equity which gives exposure to a broad basket of instruments such as equities or bonds. As an example, an ETF tracking the S&P 500, could invest in the 500 companies constituting the index, in similar weightings as in the index. This is known as physical replication, which means that the ETF provider owns the underlying physical assets. However, some newer ETFs also track derivative products such as VIX index derivatives or futures contracts, and some ETFs even apply leveraging and inverse payoffs of the underlying benchmark. ETFs are also an easy way to do thematic trading – read more here.

Traditional ETFs

A common type of ETFs track an underlying index on a one-to-one basis, just like a direct equity position. Taking the German DAX index as an example, multiple ETFs are tracking this index – one shown in the chart below, with performance since 2019. The slight underperformance of the ETF (blue) compared to the index (purple) reflects trading costs and management fees which are charged by the ETF provider to facilitate the ETF basket. The standard measure is called the Total Expense Ratio, and it may be worth checking this number when comparing ETFs tracking the same index – as well as how well the ETF performance follow the performance of the index. See more on ETF replication here.

 

Source: Saxo Group

Leveraged ETFs

Whereas traditional ETFs track an underlying benchmark on a one-to-one basis, leveraged ETFs use debt and/or derivatives to give returns in a specified multiple of the daily one-to-one return, commonly two or three times. This generally makes leveraged ETFs much more volatile than a traditional ETF. One example is shown below, where the ETF is of offering 2x leveraging, i.e. enhancing profits/losses by twice the amount of the underlying index (minus fees taken by the ETF provider plus some tracking errors). The chart below illustrates how the returns for both the Euro STOXX 50 index (purple line) and the leveraged ETF (blue line) developed since 2019.

Source: Saxo Group

Inverse ETFs

Inverse ETFs use derivatives to benefit from a value decrease in an underlying index. The inverse ETF enables you to exploit short selling without having a margin account, as you´re not shorting any instrument yourself. One example is shown below, where the French CAC 40 Index (purple) and an inverse ETF (blue) is shown. Note that tracking errors and management fees is the reason why losses in the ETF is larger than the gains in the index.

Source: Saxo Group

ETF characteristics

ETFs offer diversified industry exposure at low expense ratios and save you time on research and analysis. More specifically, the large variety of ETFs available in the Saxo platforms can enable you to tailor your portfolio according to your investment strategy and risk appetite, in any market environment. 

However, like any investment product, trading ETFs does involve risk. This is especially true of leveraged ETFs. While they use derivative products to try and amplify your potential returns on a benchmark index, conversely they will amplify your losses if the market moves against you.

Another important risk factor to bear in mind is tracking error, which refers to how much an ETF’s returns deviate from its underlying benchmark. In some instances, a high tracking error can be a good thing, if the fund is outperforming its benchmark. But if the fund is lagging the benchmark index by a wide margin, your returns will be negatively impacted – or you may even lose money on your initial investment.

Before you start trading ETFs, please make sure you understand the underlying mechanisms – especially if you want to trade derivative-tracking ETFs. Check these articles for more on liquidity and market "surprises"

The ETF industry was launched in the US in 1993 and initially created for institutional investors demanding an alternative to equity futures which exhibit rolling costs. In the beginning the demand was low, but over the following 10 years the assets under management (AUM) of equity ETFs grew as retail investors also discovered that this new financial instrument offered broad-based access to financial markets at low costs compared to active mutual funds. Especially since the financial crisis ETFs have enjoyed rapid growth in AUM by more than 200 % since 2009 to USD 2.9 trillion in the US with around 80 % tracking equity indices [BlackRock Global ETP Landscape – Industry Highlights (May 2017), BlackRock].

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)
Full disclaimer (https://www.home.saxo/legal/saxoselect-disclaimer/disclaimer)

Saxo Bank (Schweiz) AG
Beethovenstrasse 33
CH-8002
Zürich
Switzerland

Contact Saxo

Select region

Switzerland
Switzerland

All trading carries risk. Losses can exceed deposits on margin products. You should consider whether you understand how our products work and whether you can afford to take the high risk of losing your money. To help you understand the risks involved, we have put together a general Risk Warning and a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. The KIDs can be accessed here or within the trading platform. Please note that the full prospectus can be obtained free of charge from Saxo Bank (Switzerland) ltd. or the issuer.

This website can be accessed worldwide however the information on the website is related to Saxo Bank (Switzerland) Ltd. All clients will directly engage with Saxo Bank (Switzerland) Ltd. and all client agreements will be entered into with Saxo Bank (Switzerland) Ltd. and thus governed by Swiss Law.

The content of this website represents marketing material and has not been notified or submitted to any supervisory authority.

If you contact Saxo Bank (Switzerland) Ltd. or visit this website, you acknowledge and agree that any data that you transmit to Saxo Bank (Switzerland) Ltd., either through this website, by telephone or by any other means of communication (e.g. e-mail), may be collected or recorded and transferred to other Saxo Bank Group companies or third parties in Switzerland or abroad and may be stored or otherwise processed by them or Saxo Bank (Switzerland) Ltd. You release Saxo Bank (Switzerland) Ltd. from its obligations under Swiss banking and securities dealer secrecies and, to the extent permitted by law, data protection laws as well as other laws and obligations to protect privacy. Saxo Bank (Switzerland) Ltd. has implemented appropriate technical and organizational measures to protect data from unauthorized processing and disclosure and applies appropriate safeguards to guarantee adequate protection of such data.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc.