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ETF types explained: building blocks for every investor's portfolio

This is episode 3 in our ETF series. If you missed it, read episode 2: What is an ETF?

Exchange-traded funds (ETFs) come in a variety of types, each designed to serve different investment objectives. Understanding these different ETF categories is essential for building a portfolio that aligns with your financial goals. Let's explore the main types of ETFs available to Saxo Bank clients.

 

Broad market ETFs: the foundation

Broad market ETFs track major indices like the S&P 500, MSCI World, or STOXX Europe 600. These funds provide exposure to large segments of the market with a single purchase.

Real-world example: A Saxo Bank client investing €10,000 in an MSCI World ETF instantly gains exposure to approximately 1,600 companies across 23 developed markets. This single investment provides global diversification across multiple sectors and economies.

Sector ETFs: targeting specific industries

Sector ETFs focus on companies within particular industries such as technology, healthcare, or energy. These funds allow you to increase exposure to sectors you believe will outperform the broader market.

Real-world example: If you believe renewable energy will experience significant growth, a clean energy ETF gives you targeted exposure to companies developing solar, wind, and other sustainable technologies without requiring you to pick individual winners in a rapidly evolving industry.

Bond ETFs: fixed income made accessible

Bond ETFs hold portfolios of bonds, providing regular income and typically lower volatility than stock ETFs. These funds vary by duration (short to long-term), credit quality (government to high-yield), and issuer (sovereign, corporate, municipal).

Real-world example: A retiree looking for income might invest in a corporate bond ETF yielding 4% annually, receiving monthly distributions while maintaining liquidity that individual bonds don't offer.

International ETFs: going global

International ETFs focus on specific countries or regions, allowing investors to gain exposure to markets outside their home country. These range from developed markets like Japan or Germany to emerging markets like Brazil or India.

Real-world example: A European investor wanting exposure to Asian economic growth could invest in an Asia-Pacific ETF rather than attempting to navigate unfamiliar foreign exchanges and regulatory environments.

Thematic ETFs: investing in trends and innovations

Thematic ETFs focus on specific trends, innovations, or themes like artificial intelligence, cybersecurity, or aging populations. These funds identify companies across multiple sectors that stand to benefit from these long-term developments.

Real-world example: An investor believing in the future of digital payments could invest in a fintech ETF that includes traditional payment processors, cryptocurrency companies, and banking technology innovators.

The specialized category: approach with caution

Leveraged ETFs

These funds aim to deliver multiples (2x or 3x) of their underlying index's daily return. While they can amplify gains, they also magnify losses and are generally unsuitable for long-term buy-and-hold investors.

Inverse ETFs

Designed to move in the opposite direction of their benchmark, these funds increase in value when their target index falls. They're primarily used as short-term hedging tools rather than long-term investments.

Synthetic ETFs

Unlike physical ETFs that directly own the underlying assets, synthetic ETFs use derivatives and swaps to replicate index performance. This structure introduces counterparty risk—if the swap provider fails, the ETF could face losses unrelated to the underlying index.

Risk highlight: A leveraged ETF targeting 3x daily returns of an index that drops 10% in a day would lose approximately 30% of its value. Over longer periods, these funds can deviate significantly from their stated multiple of the index's total return due to the mathematics of compounding.

Understanding these ETF building blocks allows Saxo Bank clients to construct portfolios tailored to their specific investment goals, risk tolerance, and market outlook.

Next up: In episode 4, we’ll dive into how ETFs are built—exploring the differences between physical and synthetic replication, and how that affects your returns and risk.