Four Types of Nontraditional ETFs

WILLIAMSTOWN, MASS. (TheStreet) -- Nontraditional ETF strategies have created a rift in the family of ETF funds. First introduced as passive, low-cost and transparent vehicles, ETFs now utilize a host of indexing approaches. While funds like Direxion Daily Financial Bull 3X(FAS Quote), U.S. Natural Gas(UNG Quote) and iPath India(INP Quote) have drawn a considerable amount of investor attention, they are cloaked in complexity and best left to experienced investors.

The unique structure of ETFs has allowed the funds to take on exotic new incarnations. From ultra ETFs to funds of funds, the ETF industry is diving into every niche to capture market share. This new generation of ETFs strategies layer risk onto the old ETF model.

Four types of nontraditional ETFs that should be understood fully before utilized are leveraged ETFs; futures-based commodity ETFs; ETNs; and ETFs of ETFs.

Leveraged ETFs

Leveraged ETFs use futures or swaps to enhance indexing strategies, effectively allowing investors to double down or ante up. While these funds may be useful for sophisticated traders hedging a larger strategy, they are inappropriate for long term investors. These funds use a daily resetting technique that combined with volatility can erode the ETFs over time.

Also known as: Long ETFs, short ETFs, ultra ETFs

Examples: Direxion Daily Emerging Markets Bull 3X(EDC Quote), Direxion Daily Emerging Markets Bear(EDZ Quote), ProShares Ultra Financials (UYG Quote), ProShares UltraShort Financials(SKF Quote).

Futures-Based Commodity ETFs

These ETFs seek to track commodities by investing in baskets of futures or swaps. While these ETFs may get investors one step closer to a “pure play” on commodities swap prices, they are prevented by problems like contango from fully achieving their objectives. Some of these funds have become major players in their respective commodities markets, and the Commodities Futures Trading Commission (CFTC) may soon impose limits on the funds' investment capabilities.

Examples: UNG, U.S. Oil(USO Quote).