Other ETFs

Actively managed ETFs

The first exchange traded fund (ETF) - the “Spyder” - was listed for trading in 1993. For the next 15 years, only passively managed ETFs were available to investors. In 2008, the now-defunct investment bank Bear Stearns introduced the first actively managed ETF: the Bear Stearns Current Yield Fund. Although the bank would essentially go out of business later that year, it helped start a new trend in the ETF market.

Actively managed ETFs, or active ETFs, allow the fund manager to deviate from a benchmark index. For example, a large-cap active ETF might use the S&P 500 as its benchmark and invest primarily in S&P 500 stocks. However, the manager isn’t required to match the index’s exact holdings or weights. If the manager is bullish on 150 of the 500* stocks in the index, they could choose to invest only in those 150 and avoid the other 350.

*Technically, there are more than 500 stocks in the S&P 500. As of mid-2023, there were 503 stocks in the index. Regardless, this is not important for test purposes.

As discussed in the previous chapter, active management has pros and cons. An active ETF could outperform its benchmark if the manager’s selections perform well. But the additional research and portfolio management increase costs. As a result, active ETFs typically have higher expense ratios than traditional passive ETFs.

Active ETFs are gaining popularity, but passive ETFs that closely track their benchmark index still make up most of the ETF market. According to Morningstar, active ETFs comprise 4% of the ETF market but represent 10% of all ETF inflows (as of December 31, 2021). For test purposes, assume most general ETF questions focus on passive ETFs. Only apply active ETF characteristics if the question or answer choices explicitly mention active management.

Inverse & leveraged ETFs

Investors who are betting on market downturns or trying to amplify gains may use inverse and/or leveraged ETFs. These products involve considerable risk, so they’re generally suitable only for sophisticated investors.

Inverse (bear) ETFs aim to deliver the inverse (opposite) return of the index they track. If an investor expects a market or sector to fall, an inverse ETF can potentially profit from that decline.

An investor owns an S&P 500 inverse ETF. The S&P 500 goes up 3%. What is the investor’s return?

An investor owns an S&P 500 inverse ETF. The S&P 500 goes down 2%. What is the investor’s return?

Real world example - Direxion S&P 500 Bear ETF (ticker: SPDN)

Leveraged ETFs aim to deliver amplified gains and losses. The most common are 200% and 300% leveraged funds.

• A 200% leveraged ETF targets about 2× the index’s return.
• A 300% leveraged ETF targets about 3× the index’s return.

Here are a few examples:

The S&P 500 goes up 3%. How would a 200% and 300% leveraged fund indexed to the S&P 500 perform?

The S&P 500 goes down 2%. How would a 200% and 300% leveraged fund indexed to the S&P 500 perform?

Real world example - Direxion Mid Cap 3x ETF (ticker: MIDU)

Leveraged inverse ETFs also exist. These combine inverse exposure with leverage, so they can move sharply in either direction.

The S&P 500 goes up 3%. How would a 200% and 300% leveraged inverse fund indexed to the S&P 500 perform?

The S&P 500 goes down 2%. How would a 200% and 300% leveraged inverse fund indexed to the S&P 500 perform?

Real world example - Direxion Technology Bear 3x ETF (ticker: TECS)

Inverse and leveraged ETF returns can be excellent or disastrous. Even sophisticated investors typically use these ETFs for short periods. In addition to their risk, they also tend to have substantial costs. You don’t need to know the mechanics for the exam, but it’s expensive for funds to obtain inverse and leveraged returns.

Bottom line: inverse, leveraged, and leveraged inverse ETFs can produce quick gains or quick losses based on market fluctuations.