ETFs, the disruptive invention for investing.

When it comes to investing, it is common to encounter the dilemma of which instruments will be suitable and who to entrust with capital. There are two main challenges that all investors face: first, the need to diversify investments so that risks are reduced when an investment or particular sector does not perform as expected; and then, the difficulty of identifying the right opportunities in a diverse investment world where information is abundant and difficult to filter.

ETFs, the power of diversification

For this reason, an instrument called ETF emerged around 1990. ETFs can be acquired and traded in the same way as stocks or other securities, but with the versatility of grouping multiple assets, thus reducing volatility and risk, while implicitly offering diversification and optimal portfolio management.

Having ETFs in the portfolio allows the trader or investor to take a long-term orientation, while applying growth techniques to increase portfolio returns, such as selling options, backed by stocks (covered call), which would increase returns and accompany the dividends paid by the ETF.

What is an ETF?

An Exchange Traded Fund (ETF) is a type of instrument that groups different assets, such as stocks, and seeks to replicate an underlying index. ETFs include investment in different industrial sectors and combine the use of investment strategies.

ETFs have many similarities to mutual funds, but with the versatility of being traded on exchanges, as mentioned previously, and traded throughout the day, just like ordinary shares. On the other hand, mutual funds are not traded on exchanges and are only traded once a day after the markets close. It is important to note that ETFs tend to be more profitable and liquid than mutual funds, as they are more versatile and actively manage their investments to improve performance.

Types of ETFs and diversification

ETFs can contain great diversity of investments, which include stocks, commodities, bonds, or a combination of these, thus ensuring diversification. To achieve this diversification, an ETF can have hundreds or thousands of stocks in various industries. However, some ETFs focus on a particular industry or sector. ETF diversification can include its extension to different geographies, as some funds focus only on US offerings, while others have a global or market-specific perspective.

There are various types of ETFs available, which can be used for income generation, speculation, diversification, and to partially cover or offset risk in an investor's portfolio. For example:

• ETFs that replicate a particular industry, such as technology, banking, or the oil and gas sector;

• Bond ETFs can include government bonds, corporate bonds, and state and local bonds, called municipal bonds;

• Currency ETFs invest in foreign currencies such as the euro or Canadian dollar;

• Commodity ETFs invest in crude oil, metals, wood, grains and cereals, gold, among others.

• Inverse ETFs profit when the value of underlying assets decreases;

• Leveraged ETFs that move with the market, but at a faster rate.

The following chart shows a comparison between the performance of one of the S&P500 ETFs (SPY), a leveraged ETF (SPXL), and the inverse ETF (SPXS):

Performance for SPY, SPXL y SPXS

Popular ETFs in the market

Below are examples of popular ETFs in the current market. Some ETFs replicate a stock index creating a broad portfolio, while others are focused on specific industries.

• SPDR S&P 500 (SPY): The oldest and well-known ETF, replicates the S&P 500 index;

• iShares Russell 2000 (IWM): Follows the Russell 2000 small-cap market index;

• Invesco QQQ (QQQ): Indexes the Nasdaq 100, which contains technology stocks;

• SPDR Dow Jones Industrial Average (DIA): Replicates the Dow Jones Industrial Average;

• Sector ETFs: oil (OIH), energy (XLE), financial services (XLF), REIT (IYR), Biotechnology (BBH);

• Commodity ETFs: crude oil (USO) and natural gas (UNG);

• Physical backed ETFs: SPDR Gold Shares (GLD) and iShares Silver Trust (SLV) support their performance with reserves of precious materials backing them (for example, gold and silver bars).

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