Classification of ETFs

Before looking at practical elements by learning how to build a portfolio of ETFs depending on your goal, I would like to show you a classification of ETFs based on the benchmark that the basket of securities goes to replicate. Typically, they are distinguished into:

Monetary. They do not constitute a true and proper instrument of investment but arise from the need to manage the liquidity present in your account. They characteristically manage a basket of short/very short term bonds, usually 12 months or less.

The investment isn’t the purpose, but rather guaranteeing a minimal remuneration for the liquidity that is firmly in your account, even if we are currently seeing interest rates at zero or nearly zero all over the world during this historical time, the yield of these ETFs is null if not entirely negative.

Bonds. They invest in bonds and allow for broad level diversification:

• Geographical (Europe, USA, emerging countries, etc.);
• Issuer (government securities, corporate);
• Deadline (short, medium, long term);
• Currency (Euro, Dollar, exchange rate hedging, etc.);
• Income (accumulation, distribution).

As you can see, each level can be further diversified.

The advantage offered by bond ETFs is that they enable you to invest small assets while efficiently diversifying your portfolio. However, as you have seen with bonds, a key concept remains the link between interest rates and the price of the individual bonds that make up an ETF's basket.

In 2021, this is not a factor to be underestimated, especially given the low level of interest rates. An increase in rates would lead to a drop in the price of individual bonds, and as a result, a depreciation of the ETF.

Equities. They are characterized by replicating a basket of stocks. They present numerous advantages:

• Low commissions. Since with a single transaction you can buy all the shares that make up the basket;
• Low risk. The purchase of an ETF compared to a single stock has undoubted advantages in terms of lower volatility and therefore lower risk.
• Diversification. As with bond ETFs, equity ETFs can also be diversified geographically (Europe, America, Asia, Emerging Countries, etc.), by sector (banks, industry, telecommunications, real estate, etc.), by theme (allowing you to invest in a specific theme which is generally environmental, social or energy-related), etc.

As you have already seen, individual stocks are certainly not an ideal investment as they require adequate knowledge of the company you intend to invest in, as well as experience, which most of you do not possess. ETFs are definitely a better alternative for investing in the stock market.

Structured. Structured ETFs deserve a separate mention. They are synthetically replicated ETFs which invest in a basket of derivative instruments (futures) and which allow the replication of complex strategies (which until a few years ago were the exclusive prerogative of hedge funds) or non-linear strategies respecting the trends concerning reference benchmarks.

The main types of structured ETFs are:

• Short. They allow the investor to take an opposite position to the benchmark. In concrete terms, these ETFs increase in value when the benchmark falls in price. They are therefore a way of speculating on the downside of financial markets.
• Leveraged. They allow the investor to realize an additional return (but also a loss) with respect to the benchmark. The additional return is determined by the leverage effect, which allows the performance of the benchmark to be amplified. For example, if the benchmark earns 1.5% today, a "3x leveraged ETF" earns 4.5% (1.5% x 3 = 4.5%). If tomorrow the benchmark achieves -2%, the same ETF will lose 6% (-2% x 3 = -6%).

They are therefore instruments that need to be treated with care and only by experienced people. Moreover, they are much more suitable for speculation (trading) than for investment. This is why I do not recommend the use of structured ETFs and why you won’t find them mentioned again in this course.

In conclusion, you have seen how ETFs are very versatile tools that allow you to invest with low costs and low risks, even with little capital, diversifying in many ways and in different markets. It’s the ideal tool for those who want to make an accumulation plan.