ETF essentials · 2 minute read
What does the ETF actually track?
The short answer
An ETF is designed to follow an index or investment strategy. Before looking at its cost or past performance, make sure you understand what the ETF invests in and how investments are chosen.
Why it matters
ETF names can sound broader or simpler than the investment really is. Words such as “global”, “sustainable”, “technology” or “income” do not all mean the same thing.
For an index-tracking ETF, the index rules determine features such as:
- Which companies or bonds can be included
- How many investments are held
- How each investment is weighted
- Which countries and sectors are represented
- How often the index is reviewed and rebalanced
Some indices give larger companies a larger weighting. Others give each company a similar weighting, or select investments using rules based on factors such as value, dividends, size or environmental characteristics.
An actively managed ETF gives its manager discretion to choose investments within a stated objective. It may use an index as a comparison benchmark without trying to track it. Check the objective and how much freedom the manager has.
A simple example
Two ETFs may both describe themselves as “global equity ETFs”. One may cover developed markets only. Another may include emerging markets. One may hold over 1,000 companies, while another may hold only a few hundred.
They may therefore behave differently, even though their names sound similar.
What to check
- Does the ETF track an index or use an active strategy?
- What index or investment objective does it use?
- Which countries and sectors are included?
- How many holdings does it contain?
- How are holdings weighted?
- Are emerging markets included?
- Are there exclusions or sustainability screens?
Key term explained
An index is a set of rules used to measure or represent part of an investment market. An ETF that follows an index aims to deliver similar performance, before costs and other factors.
Do not choose an ETF based on its name alone. Read the index rules or active investment policy and check what the fund actually invests in.