by SoniS

Created on: August 16, 2008   Last Updated: August 19, 2008

Investing tools that hold multiple companies under one umbrella integrated by a specific investing theme are called "Funds".

Exchange-traded Fund or an ETF tracks an index, a commodity or a group of assets, but when it comes to trading on a stock exchange, it trades exactly like a stock.

The different types of ETFs in the financial market are Short, Ultra Short, Commodity and Actively Managed.

Short ETFs are those that employ financial derivatives to get a return that matches a multiple of, or the inverse of, the daily performance of the index.

Ultra Short ETFs consist of "short positions" in an assortment of stocks. Having a "short position" in a stock is like the opposite of buying the stock. This essentially means that you make money if the stock goes down. By "ultra", we mean that the returns are double. So, an Ultra Short ETF proceeds at an inverse relationship to the stocks it represents, always multiplied by two.

As the name suggests, Commodity ETFs invest in precious metals and futures.

In the United States, Actively Managed ETFs have been made available since 25th of March, 2008. These ETFs are required to publish their holdings each day on their websites. The transparency of Actively Managed ETFs puts them at risk from brokers prone to front-running. Front-running is an illegal activity which involves a broker buying for his own account in order to increase or decrease the price of the share to benefit his customer. Another factor which inhibits the popularity of Actively Managed ETFs are the absence of back-tested data.

ETF vs. Mutual Funds

In spite of the fact that both ETFs and Mutual Funds fall under the category of Index Funds, they differ in various aspects.

ETFs do not have their Net Asset Value (NAV) calculated everyday like a Mutual Fund, instead, its price varies as it is bought and sold throughout the day.

Being Index funds, both ETFs and Mutual Funds offer diversification but an ETF provides you with the capability to sell short, buy on margin, use a stop-loss order, use a limit order and purchase as little as one share. Although, buying one single share may not be considered a wise financial decision under most circumstances.

Most ETFs can boast of a lower expense ratio when compared to an average Mutual Fund. Usually, while buying and selling ETFs, you have to pay your regular brokerage. But, since the onset of low-cost or free transactions, ETFs have managed to obtain a favorable position as opposed to Mutual Funds.

Tax, is of course, inevitable for both funds. But here again, the basic structure of an ETF helps it steer clear of capital gains and other tax horrors.

ETFs are definitely gaining momentum since they began in the early 1990s. But, before investing, make sure you do a thorough background check and are ready to be patient with both gains and losses.

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