During our "ETFs for beginners" lesson, we discussed ETF classifications. In this lesson, we will focus on the three most common types of ETFs: Index ETFs, Stock ETFs, and Leveraged/Inverse ETFs.
1.How to Choose Index ETFs?
When evaluating Index ETFs, particularly when comparing ETFs of the same category, it's worthwhile to consider the following four key aspects:
(1) Trading Volume:
The trading volume determines the liquidity of the ETF. Generally, higher trading volume signifies higher liquidity.
Good liquidity means that when you trade, whether you're buying or selling, transactions are easier to execute and there is lesser risk of encountering difficulties in finding buyers or sellers in the market.
This means that buyers could acquire ETFs at lower prices, reducing their overall costs. Conversely, sellers could sell their ETFs at higher prices, potentially increasing their profitability.
Bid-ask spread data is readily available on the Tiger Trade app's interface. Take, for instance, the Tracker Fund (02800.HK), one of the prominent ETFs that mirrors the Hang Seng Index. When accessing the trading interface for the Tracker Fund, you will find listed bid and ask prices. Typically, as an ETF's trading volume increases, the bid-ask spread decreases in size, signifying enhanced liquidity.
（Source: Tiger Trade app. Graphics and charts are for illustrative purposes only, and are not financial advice.）
(2) Asset Size:
The popularity of an ETF is often reflected in its asset size, and generally, larger ETFs come with several advantages.
As an ETF's size grows, the impact of expenses such as management fees and custody fees would typically be reduced, percentage wise. Furthermore, larger ETFs are more likely to be better equipped to handle substantial capital inflows or outflows, making their operations smoother.
（Source: Tiger Trade app. Graphics and charts are for illustrative purposes only, and are not financial advice.）
On the contrary, smaller ETFs carries a higher risk of being delisted. Although delisting usually involves returning cash at net asset value, it can pose potential risks such as reinvestment challenges and liquidation costs.
Even among ETFs tracking the same index, their asset sizes can vary significantly. Hence, one could consider looking at the largest ETF within the same category when making investment choices.
(3) Premium/Discount:
The premium/discount of an ETF refers to the difference between its off-exchange market price and its net asset value (NAV). When an ETF trades at a higher price than its NAV in the off-exchange market, it has a premium, and when it trades at a lower price, it is on a discount.
You can understand this with a simple formula:
Premium/Discount = (ETF's trading price - ETF's indicative optimized portfolio value (IOPV)) / ETF's indicative optimized portfolio value (IOPV) × 100%
In practical trading, manual calculations are not necessary; rather, it is essential to understand how to leverage premium/discount information when executing ETF transactions.
A positive value signifies that the ETF is trading at a premium, whereas a negative value indicates a discount. This data can be readily accessed through the market interface of the Tiger Trade app.
To illustrate, let's consider the case of the Tracker Fund, which exhibited a premium/discount rate of 0.9% at a specific trading instance. This information imparts two critical insights:
（Source: Tiger Trade app. Graphics and charts are for illustrative purposes only, and are not financial advice.）
1. Currently, the Tracker Fund's price is slightly higher than its IOPV. Buying at that price might incur a premium.
2. A premium generally suggests positive investor sentiment. However, if the premium is too high, it can lead to overheated ETF trading sentiment for a period of time, and then followed by a correction.
Hence, the premium/discount rate serves as a valuable tool for insights on the optimal timing for acquiring an ETF. The higher the premium rate, the more expensive it is to acquire the ETF at that moment.
(4) Fees:
ETF fees typically include brokerage commissions, transaction levies, trading fees, trading system usage fees, and stamp duties, among other items.
The impact of ETF fees on investment returns becomes significant when it is compounded. Even minor fee differences can cause significant return disparities over long-term investments.
Therefore, when all of the other three indicators (trading volume, asset size, premium/discount) meet your requirements, selecting an ETF with lower fees would be a wiser choice.
You can find information on ETF fees in the Tiger Trade app by clicking on "Announcement" in the ETF market interface, then selecting "Listing Documents" under "Company Announcement" to view the "Product Asset Summary."
2.How to Choose Stock ETFs?
The selection of Stock ETFs is generally more subjective than Index ETFs. Typically, you can consider screening Stock ETFs based on two dimensions: industry/theme and country/region.
(1) Industry/Theme ETFs:
Stock ETFs can focus on either certain industries, or themes, such as technology, healthcare, renewable energy, or consumer goods. These ETFs aim to track the performance of companies within a particular sector or theme.
Within these industries, you can pick industries or themes that are growth-oriented or have high growth potential. For example, if you are optimistic about developments in communication technology, you can find ETFs in the telecommunications industry. Similarly, if you believe in innovative pharmaceuticals, you can explore ETFs in the healthcare industry.
(2) Country and Region ETFs:
Country and region ETFs generally invest in a specific market. For example, Japanese ETFs (EWJ), S&P 500 ETFs (SPY), Nasdaq 100 ETFs (QQQ), German ETFs (EWG), or Hang Seng Tech ETFs (03032).
Allocating to Exchange-Traded Funds (ETFs) from different countries and regions offers several advantages for investors:
One of the primary advantages is diversification. By investing in ETFs from various countries and regions, you spread your investment across different markets and economies. This reduces the impact of poor performance in any single market on your overall portfolio.
（Source: Tiger Investment Research Team. This table is for illustrative purposes only and it is not investment advice）
Tiger Investment Research Team tabulated backtested data for investing in single markets versus diversified markets from January 2005 to August 2023, gross of fees.
The data showed that if you only invested in a single market, such as the CSI 300 Index or the S&P 500 Index, the annualised compounded returns during this period were 9.83% and 9.45%, respectively.
However, by splitting investments equally between these two indices (a China-US equal weight strategy), you could achieve an annualized compounded return of 10.65%, surpassing the returns from investing in a single market by 1%.
Additionally, the annualized volatility and maximum drawdown were relatively moderate. The Sharpe ratio for the equal-weighted strategy was also close to that of the S&P 500 Index.
（Source: Tiger Investment Research Team ）
The images above show that diversifying by investing in ETFs from different regions effectively reduces the volatility and risks associated with a single market, whether it's in terms of returns or drawdowns.
In summary, for investors with a preference for stability, diversifying with regional ETFs could be an excellent choice.
3.How to Choose Leveraged/Inverse ETFs?
When selecting Leveraged/Inverse ETFs, you can focus on three dimensions:
(1) Underlying Asset: Begin your investment journey by defining the asset category in which you wish to invest. Clearly identify the indices or individual stocks you hold a positive or negative outlook for. These could encompass major indices like the Hang Seng Index or CSI 300 Index, prominent large-cap stocks such as NVIDIA, commodities such as gold, and other pertinent options.
(2) Investment Direction: Your investment direction should align with your market sentiment. It's a straightforward decision: opt for leveraged ETFs when you hold a bullish view and consider inverse leveraged ETFs when your outlook is bearish. However, please bear in mind two critical considerations:
a. Profound Market Insight: Both leveraged and inverse leveraged ETFs necessitate a keen understanding of market trends and sectors. An incorrect assessment of market conditions can magnify your losses significantly.
b. Risk of hitting "Zero" for Inverse ETFs: Inverse ETFs are primarily composed of various derivatives. Consequently, as the underlying index continues to rise, the price of an inverse ETF declines. In theory, when the index experiences a certain level of growth, the value of the inverse ETF may reach zero. In such cases, the issuer may announce the dissolution of the ETF to prevent its asset value from turning negative.
(3) Leverage Level: Select an appropriate leverage level that aligns with your risk tolerance and return expectations. Leveraged and inverse ETFs offer different multiplier options, such as 0.5x, 2x, 3x, and so on. It's crucial to recognize that the higher a multiplier the higher its risk.
In summary, the three key points mentioned —underlying assets, investment direction, and leverage levels—constitute the foundation of your investment strategy. Tailor your choices in these areas to suit your specific return objectives and risk appetite.
With the completion of this section, you now possess a comprehensive understanding of how to swiftly identify Index ETFs, Stock ETFs, and Leveraged/Inverse ETFs. In the next lesson, we will delve into the scientific allocation of these ETFs to optimize your strategy's returns.
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