Exchange-traded funds (ETFs) combine aspects of mutual funds and conventional stocks. Like a mutual fund, an ETF is a pooled investment fund that offers an investor an interest in a professionally managed, diversified portfolio of investments. But unlike mutual funds, ETF shares trade like stocks on stock exchanges and can be bought or sold throughout the trading day at fluctuating prices.
ETFs differ in structure and vary in a number of ways:
1. Management style. Many ETFs are designed to passively track a particular market index and are similar to index mutual funds. These ETFs aim to achieve the same return as the index that they track, by investing in all or a representative sample of the stocks included in the index. In recent years, actively managed ETFs have emerged as another choice for investors. The portfolio manager of an actively managed ETF buys and sells stocks in accordance with an investment strategy, rather than tracking an index.
2. Investment objective. Investment objectives vary by ETF and the management style of a given ETF. The objective of passively managed ETFs is to replicate the performance of the index the ETF tracks. On the other hand, advisers of actively managed ETFs invest to achieve a particular investment objective by making investment decisions themselves. Some passively managed ETFs aim to earn a return that is a multiple or a reverse (inverse) multiple of the return of a particular stock index. These are referred to as leveraged or inverse ETFs. An ETF’s investment objective is stated in its prospectus.
3. Indices tracked. ETFs track a huge variety of indices. Some indices are very broad market indices, such as total stock or bond market indices. Other ETFs track indices that are narrower, such as those made up of medium and small companies, only corporate bonds or just international companies. Some ETFs track extremely narrow—and sometimes very new—indices that might not be fully transparent or about which little is known.