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 made 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 started a new trend in the ETF markets.

Actively managed ETFs, or simply active ETFs, allow the fund manager to deviate from their benchmark index. For example, a large-cap active ETF would likely consider the S&P 500 its benchmark index and the fund manager would primarily invest in S&P 500 stocks. However, they are under no obligation to match the exact structure of the index. If they were bullish on 150 of the 500* stocks in the index, they could simply avoid investing in the other 350 stocks.

*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 we discussed in the previous chapter, active management comes with pros and cons. An active ETF could outperform its benchmark index if the chosen investments perform well. But, the added research and asset management services come at a cost. Therefore, active ETFs maintain higher expense ratios than traditional passive ETFs.

Active ETFs are gaining popularity, but passive ETFs that closely track their benchmark index still comprise most of the ETF market. According to Morningstar, active ETFs only comprise 4% of the ETF market, but represent 10% of all ETF inflows (as of December 31, 2021). For test purposes, you should assume passive ETFs are the focus of general ETF test questions on the exam. Only consider active ETF characteristics if explicitly mentioned in the question or answers.

Inverse & leveraged ETFs

Investors betting on market downturns or seeking to amplify their gains could purchase inverse and/or leveraged ETFs. These investments come with considerable risk, which makes them suitable only for sophisticated investors.

Inverse (bear) ETFs provide the inverse (opposite) return of the index they track. For investors betting a market or sector will generally fall, inverse ETFs can be utilized to make a return. Here’s how these would work:

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 provide amplified gains and losses to their investors. 200% and 300% leveraged funds are the most common leveraged ETFs. 200% leveraged ETFs amplify gains and losses by a factor of 2, while 300% leveraged ETFs amplify gains and losses by a factor of 3. Let’s take a look at a few examples of how these work:

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 in the market. In essence, they’re leveraged and inverse ETFs molded together as one. Leveraged inverse ETFs come with considerable risk, as you’ll see below:

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 amazing or terrible. Even the most sophisticated investors should only maintain an investment in these ETFs for short periods. Not only are they risky, but they come with substantial costs. Although you don’t need to know the specifics, it’s expensive for funds to obtain inverse and leveraged returns.

Bottom line - inverse, leveraged, and leveraged inverse ETFs provide ways to make or lose quick money based on market fluctuations.