What are ETFs?

ETFs are exchange-traded funds that usually try to replicate a capital market index. This means that ETFs aim to achieve the same return (after costs) as the index.

What types of ETFs are out there?

Some ETFs buy exactly the same securities as those included in the index (fully replicating ETFs). This method is suitable for liquid and developed markets. Other ETFs only hold a representative portion of the securities included in the index (replicating ETFs using sampling). This could be expedient where it is not cost-efficient to replicate the index perfectly. Then there are ETFs that use a derivative structure (total return swap) to track an index by purchasing the index return on the basis of a contract with a suitable counterparty (synthetic ETFs). The resulting counterparty risk depends in turn on how the derivative is collateralized.

Leveraged ETFs and short ETFs

There are also ETFs on the market that use leverage, i.e., they intend to double or triple the daily performance of the index. Or they do the opposite, i.e., they aim to achieve the negative daily return of the index (short ETFs). These instruments are speculative in nature and may have their uses in the short term, but investors should be able to understand them fully. We do not use leveraged ETFs, let alone short ETFs, because the underlying mechanisms cause investors to lose in sideways markets.