What is an ETF?

Leveraged ETFs

Whereas traditional ETFs track an underlying benchmark on a one-to-one basis, leveraged ETFs use debt and/or derivatives to give returns in a specified multiple of the daily one-to-one return, commonly two or three times. This generally makes leveraged ETFs much more volatile than a traditional ETF. One example is shown below, where the ETF is of offering 2x leveraging, i.e. enhancing profits/losses by twice the amount of the underlying index (minus fees taken by the ETF provider plus some tracking errors). The chart below illustrates how the returns for both the Euro STOXX 50 index (purple line) and the leveraged ETF (blue line) developed since 2019.

Inverse ETFs

Inverse ETFs use derivatives to benefit from a value decrease in an underlying index. The inverse ETF enables you to exploit short selling without having a margin account, as you´re not shorting any instrument yourself. One example is shown below, where the French CAC 40 Index (purple) and an inverse ETF (blue) is shown. Note that tracking errors and management fees is the reason why losses in the ETF is larger than the gains in the index.

ETF characteristics

ETFs offer diversified industry exposure at low expense ratios and save you time on research and analysis. More specifically, the large variety of ETFs available in the Saxo platforms can enable you to tailor your portfolio according to your investment strategy and risk appetite, in any market environment. 

However, like any investment product, trading ETFs does involve risk. This is especially true of leveraged ETFs. While they use derivative products to try and amplify your potential returns on a benchmark index, conversely they will amplify your losses if the market moves against you.

Another important risk factor to bear in mind is tracking error, which refers to how much an ETF’s returns deviate from its underlying benchmark. In some instances, a high tracking error can be a good thing, if the fund is outperforming its benchmark. But if the fund is lagging the benchmark index by a wide margin, your returns will be negatively impacted – or you may even lose money on your initial investment.

Before you start trading ETFs, please make sure you understand the underlying mechanisms – especially if you want to trade derivative-tracking ETFs. Check these articles for more on liquidity and market "surprises". 

The ETF industry was launched in the US in 1993 and initially created for institutional investors demanding an alternative to equity futures which exhibit rolling costs. In the beginning the demand was low, but over the following 10 years the assets under management (AUM) of equity ETFs grew as retail investors also discovered that this new financial instrument offered broad-based access to financial markets at low costs compared to active mutual funds. Especially since the financial crisis ETFs have enjoyed rapid growth in AUM by more than 200 % since 2009 to USD 2.9 trillion in the US with around 80 % tracking equity indices [BlackRock Global ETP Landscape – Industry Highlights (May 2017), BlackRock].