What is an ETF?
ETFs explained: meaning, types, costs and risks
Whether you're new to investing in Exchange Traded Funds (ETFs) or looking to build on what you already know, this guide explains what ETFs are, how they work and how to invest in them as a UK investor – from the basics to costs, risks and tax.
Author: Navisha Joshi | Euan Jones
Last updated: 2 July 2026
ETFs in brief
Exchange traded funds (ETFs) are a simple, cost-effective way to invest in a diversified basket of assets – such as stocks and bonds – across different sectors, themes and regions.
- There are two main types of ETFs based on their approach: active (managed with the aim of outperforming an index or achieving a specific outcome) and passive (index-tracking).
- ETFs trade on stock exchanges, much like shares, giving investors flexibility, transparency and liquidity.
- Developing an understanding of ETF fees, spreads and charges can make a significant contribution to your long-term investment goals.
- As with all investing, ETFs carry risks. Understanding the different types of funds available can help you make informed decisions.
This guide covers key things you need to know about ETFs as a UK investor, from how these funds work to how to invest in them.
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What is an ETF?
An ETF is a type of investment fund that holds a basket of assets, such as stocks, bonds or commodities, and trades on a stock exchange, just like a share. In the UK, ETFs are widely used by both professional fund managers and individual investors as a flexible, cost-efficient way to build a diversified portfolio.
The term ‘ETF’ simply stands for Exchange Traded Fund. This means you can buy and sell these funds on a stock exchange throughout the trading day at their market prices, unlike traditional funds, which are typically priced once a day.
In short: ETFs are an easy route to purchasing a pool of assets without having to buy each one individually. A globally diversified, multi-asset, ETF-based portfolio can provide exposure to numerous underlying investments in a single transaction.
Here’s a table showing the key ETF types and styles across management approach, focus, structure, and replication method:
Exchange Traded Funds (ETFs): Types and Styles
Management style | Focus | Structure | Method of replication |
|---|---|---|---|
Passive: tracks an index. | Geography: e.g. FTSE 100 tracking fund in the UK. | Physical: owns the underlying securities in an index. | Full replication: invests in all underlying companies in an index. |
Active: aims to achieve a defined investment objective. | Sector: e.g. technology firms. | Synthetic: uses financial derivatives to replicate index performance. | Sampling: invests directly in a representative subset of securities in an index. |
Smart Beta: rules-based portfolios, typically factor-oriented. They use an ‘enhanced indexing’ strategy where minor tilts are made against the benchmark by focusing on different factor exposures such as growth, value and quality. | Theme: e.g. energy infrastructure. | Optimisation: similar to sampling but with the additional sophistication of using a quantitative model to select and weigh a subset of securities that closely track the index, potentially producing lower tracking errors and costs. | |
Fixed income: baskets of bonds. |
Source: J.P. Morgan Personal Investing. ‘Factor-oriented’ Smart Beta ETFs select and weight their investments based on specific investment factors such as whether an investment appears undervalued relative to the market or has higher growth prospects.
What can ETFs invest in?
ETFs are highly versatile and the short answer to what they can invest in is any underlying asset that has sufficient liquidity. An ETF can track an entire index, a specific sector, a region or even a theme such as artificial intelligence or clean energy. They can capture broad swathes of financial markets, from tracking the Russell 3000 – which aims to capture the vast majority of the US stock market – to niche markets that target specific sectors or themes for instance.
The ETF market is vast, with around 14,500 ETFs available worldwide.* The table below shows different diversification options that ETFs can help provide.
ETF focus | Example |
|---|---|
Asset classes | Government bonds, equities, commodities |
Stock market indices | FTSE 100, S&P 500, Russell 3000 |
Regions | Europe, US, Asia-Pacific, Global |
Sectors | Technology, healthcare, energy |
Market segments | Small-cap stocks, mid-cap stocks, large-cap stocks |
Themes | Renewable energy, robotics, AI |
*J.P. Morgan Asset Management’s Guide to ETFs, data as at 31 March 2026.
ETF management styles
ETFs serve as a vehicle for different investment strategies to reach different objectives. At the headline level, there are two main management styles: passive and active.
While passive funds have historically been the predominant type of ETF, actively managed ETFs are becoming increasingly popular. J.P. Morgan Asset Management reports that in the US, active ETFs took in about 42% of all asset flows into ETFs over the first three months of 2026.
Let’s take a look at each of these ETF management styles in detail.
Passive ETFs (index tracking)
A passive ETF aims to track the performance of an index, often broad market indices such as the FTSE 100 or the S&P 500. Being ‘passive’ means that the fund follows a clearly defined benchmark and does not attempt to beat it; it aims to replicate the index as closely as possible. A passive ETF gives the investor exposure to whichever index (such as broad-based, sectoral or thematic) it is tracking.
How does passive ETF replication work?
Imagine an index that is made up of 100 stocks and has a total market capitalisation of £100 billion. Let’s assume that:
- Company A has a market cap of £5 billion → it accounts for 5% of the index
- Company B has a market cap of £500 million → it accounts for 0.5% of the index
- An ETF tracking that index using the full replication method would hold investments in all 100 companies in the same proportion as their index weightings.
- The ETF would be 5% allocated to Company A, 0.5% allocated to Company B, with the remaining 98 companies held on the same basis: how valuable they are as a proportion of the whole index.
Full replication involves the ETF physically investing in all constituent members of the index it is aiming to track. This is typical for highly liquid markets, where buying and selling of underlying securities is straightforward and cost-effective.
There are other ways passive ETFs are set up. The investment objectives of the ETF and the characteristics of the market it is tracking will differ, and the replication method used will differ accordingly. Some are more suited to specific market characteristics, while others may use a combination of methods in a ‘hybrid’ approach (an optimised approach to replicate the characteristics of the main index where holding each constituent is unfeasible, often seen in fixed income ETFs).
Active ETFs
Active ETFs do not aim to track the performance of a benchmark index. Instead, a professional fund management team makes active investment decisions with the aim of achieving specific objectives – such as generating a certain level of income or outperforming a reference index.
These ETFs combine the potential benefits of active management, such as the security-selection expertise of investment experts, with the many advantages of the ETF vehicle such as cost-efficiency, transparency and liquidity.
Key characteristics of active ETFs:
Feature | Detail |
|---|---|
Objective | Outperform a reference index or achieve a specific outcome (such as generating income) |
Management | Portfolio managers make active decisions on which shares, sectors or bonds to invest in |
Potential upside | Opportunity to generate Alpha (an investment’s excess return performance relative to the benchmark) |
Use case | As core portfolio holdings, tactical allocations when appropriate, or income generation |
J.P. Morgan Asset Management is one of the top industry leaders in the space, with 47 active ETFs available in the US. As at March 2026, assets under management totalled over $220.9 billion in active US ETFs (Source: J.P. Morgan Asset Management Guide to ETFs).
For an active ETF that is aiming to outperform a reference index, the portfolio management team uses their research and investment expertise to take distinct positions, rather than holding investments strictly in line with index weights. This may mean that the weighting of a stock or a sector is slightly higher or lower than the index, depending on whether they have a more positive or negative viewpoint.
Relative to passive ETFs, active ETFs typically introduce higher tracking error risk. Tracking error is a financial metric that measures how well the ETF replicates the performance of the reference index. Given passive ETFs' goal of replicating the performance of a reference index, a low tracking error is typically targeted. For active ETFs, there is naturally the potential for higher tracking error, but alongside this they can help investors to gain ‘Alpha’ (risk-adjusted outperformance) in a portfolio alongside core passive holdings. Active ETFs can also be used for tactical allocations at different times through the market cycle.
Smart Beta ETFs
Smart Beta ETFs usually sit within the active category, but they take a slightly different approach. Rather than weighting holdings purely based on market capitalisation, they select and weight the shares using a rules-based, systematic approach. These ETFs tilt towards other fundamental factors such as value (shares that appear underpriced), momentum or dividend yield. They aim to generate small levels of outperformance and reduce risk compared to the benchmark.
How do ETFs work?
ETFs hold their underlying assets through either physical or synthetic structures.
Physical ETFs
Physical ETFs directly invest in the underlying securities of the index they are tracking. There are three commonly used replication methods for physical ETFs:
Method | How it works | Best suited for |
|---|---|---|
Full replication | Holds all securities in the index in their exact weightings | Large, liquid markets (e.g. FTSE 100 or S&P 500) |
Sampling | Invests directly in a representative subset of securities that closely match an index’s risk and return characteristics | Large fixed income markets with thousands of constituents |
Optimisation | Uses optimisation techniques to replicate the risk and return profile of an index where there are difficulties in achieving full replication | Fixed income index replication |
Synthetic ETFs
Synthetic ETFs do not invest in an index’s underlying physical securities. Instead, they invest in financial derivatives, specifically 'swaps', to replicate the performance of the target index.
How do synthetic ETFs work?
- The ETF provider enters into a legal agreement (a swap) with a counterparty (typically a bank).
- The counterparty agrees to deliver the return of the target index to the ETF.
- In exchange, the ETF provides the return generated by a basket of securities.
- This basket also serves as collateral to provide protection if the counterparty is unable to fulfil its obligations under the agreement.
Synthetic ETFs can carry some credit risk – the possibility that the counterparty is unable to fulfil its obligations – compared with physical ETFs. However, in recent years ETF providers have significantly improved the mechanism to protect themselves against this.
When are synthetic ETFs used?
- When investors find it difficult, inefficient or non tax-efficient to invest in an index’s underlying securities.
- In niche markets, financial derivatives may be a more efficient way to gain exposure.
Synthetic ETFs may provide lower administration and operational costs, better replication of specific assets and can bring down the total expense ratio.
Risk note: Synthetic ETFs may carry counterparty risk, which is the possibility that the counterparty cannot fulfil its obligations. ETF providers have significantly improved protections against this in recent years, but it is recommended to consider it when selecting funds.
Range of ETFs
The ETF universe is extensive, with continuous innovation seeing the expansion of the number and type of funds available. Three common types of market exposure that ETFs capture are:
- Geography: The most popular type of ETFs tracks large, well-diversified indices covering a country, region or the entire global market. For example, indices such as the S&P 500 or the Russell 3000 (which captures almost the entire US stock market). In the case of Russell 3000, the underlying stocks are highly diversified and likely to encompass both household names and lesser-known companies from a range of industries.
- Sector: These ETF types track a particular sector, be it technology, healthcare, energy or many others. Investors may favour a sector ETF in order to benefit from the business cycle or to leverage one sector’s risk-reward characteristics. For example, the technology sector may be prone to more volatility than a traditionally more stable sector like defence.
- Theme: Thematic ETFs focus on long-term trends and themes. This can range from the energy transition to robotics, artificial intelligence and healthcare innovation. They tend to be more concentrated than broad-market ETFs and as a result can carry higher risk.
- Fixed income: Fixed income ETFs invest in baskets of bonds, providing exposure to debt markets. They may track a broad bond index or narrow segments such as government bonds, investment-grade corporates or municipal bonds. Their returns are impacted by yields, interest rate changes, and issuer credit quality or spreads. Fixed income ETFs traditionally started out as passively managed, however, the actively managed fixed income ETFs market has now grown significantly.
Our approach to ETFs
At J.P. Morgan Personal Investing, ETFs are our investment vehicle of choice. ETFs can make it easier to invest in a broad, diversified slice of the market through a single fund. Below are some of the reasons why ETFs are the preferred investment vehicle for our portfolio managers.
Why ETFs are our investment vehicle of choice for managed portfolios
Cost efficiency
An ETF tracking a developed equity market such as the S&P 500 can cost as little as 0.05% of the amount you invest in the ETF per year. At times, the cost of investing in active ETFs can be slightly higher. However, this comes with the potential for outperformance, or the potential to achieve a specific investment outcome, such as a certain level of income generation. They offer a cost-efficient way to target investment outcomes that may not be possible by using passive ETFs alone.
Diversification
Investing in ETFs is an effective way to create a globally diversified, multi-asset portfolio. Passive ETFs can be used as core building blocks of a portfolio, such as those following broad-based and well-diversified indices, spreading the risk of your investments across many securities. Buying an ETF that tracks an index such as the S&P 500, which typically uses the ‘full replication’ method, is comparable to buying a small part of each of its constituent stocks in the appropriate proportion, providing exposure to a large share of the US equity market’s total capitalisation. This is more straightforward than it would be for an individual to do themselves, as well as coming at a much lower cost.
ETFs like these can be the core portfolio holdings, which can then be complemented by ETFs that provide exposure to more specific asset classes. This may be regional or sectoral ETFs for example, as well as active ETFs that aim to outperform their reference index or achieve specific investment objectives.
Our investment team constructs portfolios using a mixture of ETFs covering different asset classes, enhancing the diversification of portfolios.
Choice
Our investment team chooses from a universe of over 2,000 ETFs for our managed portfolios. We consider many factors when choosing our investments and hold both physically backed and synthetic ETFs with high liquidity, so that they are easier to buy and sell. The investments in our portfolios are reviewed regularly to ensure they are the most suitable for our customers' needs.
Flexibility and liquidity
Just like individual stocks, ETFs can be traded whenever the relevant stock exchange is open, making them a flexible way to invest. This differs from some other collective investment vehicles like unit trusts, which are typically priced once a day. They have also proved to be an effective vehicle for fractional trading – where partial shares of ETFs can be traded rather than whole units. At J.P. Morgan Personal Investing we typically invest twice a week.
Transparency
Investors can typically see the underlying positions the ETF is invested in at any given time through the daily disclosure. This is not the case across all other types of collective investment vehicles.
How we select our ETFs
The global ETF market has grown substantially in recent years with assets under management having increased from a little over $2 trillion in 2014 to stand at nearly $20 trillion in March 2026. There are now around 14,500 ETFs available worldwide.*
Selecting the right funds usually requires deep market knowledge and rigorous analysis. There are several factors, as listed below, that our experienced portfolio managers use when selecting ETFs.
Key considerations in our ETF selection process:
Consideration | What we look at |
|---|---|
Components of the market index | Whether the index is suitably diversified and aligns with our investment view. We also evaluate if any company, sector, or country has an outsized weighting and the justification behind it. |
Method of replication and tracking error | We look at what is known as the tracking difference of each ETF – how closely the ETF manager has matched the performance of the index – and look to select funds that are as closely aligned to our approach as possible. |
Costs | We aim to hold the fund with the lowest overall costs (subject to other factors listed in the table here): a low total expense ratio (TER) and internal trading costs, to offer the highest available overall value to our clients. |
Size, trading volume and liquidity | We avoid investing large amounts in ETFs where trading volume is limited, as it can be more difficult and costly to trade. We aim to use the ETFs with the lowest bid-offer spreads as these are typically the most liquid. |
Physical or synthetic | We invest in both physical and synthetic ETFs. Physical ETFs are the most common ETFs in the marketplace and directly hold the underlying securities. |
Currencies traded in | ETFs are commonly traded in sterling, US dollars and euros. However, for our managed portfolios we only invest in ETFs that are traded in sterling. While ETFs tracking non-UK indices, such as the S&P 500, are available in sterling, they are still at risk of currency fluctuations. This is due to the underlying constituent companies being based in the US. We consider this currency risk when investing in an ETF and in certain circumstances, we may invest in a ‘currency-hedged’ version of a fund to mitigate the risk. |
Once we've selected our ETFs, we use proprietary macroeconomic and market research to assess the asset allocation of our portfolios and rebalance or make changes when opportunities arise.
*J.P. Morgan Asset Management’s Guide to ETFs, data as at 31 March 2026.
Do we hold active ETFs in our portfolios?
Yes, our collaboration portfolios with J.P. Morgan Asset Management; Smart Alpha (powered by J.P. Morgan Asset Management) and Income investing, utilise active ETFs. The rest of our range; Fully Managed, Socially Responsible, Thematic investing and Fixed Allocation can hold active ETFs at the discretion of our investment team. However, the overall portfolios are predominantly built using passive ETFs.
Have we considered cryptocurrency ETFs?
The cryptocurrency space continues to attract attention globally. While the market has evolved a great deal in recent years, we do not currently invest in cryptocurrency ETFs within our managed portfolios.
The investment team has a broad range of investment opportunities through which to look for potential returns for investors. We continue to monitor developments in the cryptocurrency ETF space as it matures, and will continue to consider the possible viability of offerings for our managed portfolios.
Are ETFs safe?
As with all investments, ETFs carry some level of risk. Understanding the main types of risks involved can help you make more informed decisions about how and where to invest.
Risk type | What it means |
|---|---|
Market risk | The value of an ETF can rise and fall owing to the performance of the underlying assets. |
Concentration risk | ETFs can sometimes be heavily exposed to a small number of companies, sectors or themes. Sectoral or thematic ETFs tend to be less diversified than broad‑market ETFs, causing any movement in one industry or theme to have a disproportionate impact. Concentration risk can also arise from the index itself; even ‘broad’ benchmarks can occasionally become top‑heavy when a few large stocks dominate returns (for example, a single mega‑cap forming a large portion of an index). |
Currency risk | ETFs tracking non-UK indices (e.g. S&P 500) are exposed to currency fluctuations. This applies even if the ETF is priced in sterling as the underlying assets may operate in other currencies. |
Liquidity and spread risk | Funds that track less liquid markets may have wider bid-offer spreads. This makes them more costly to buy and sell. |
Counterparty or credit risk | This applies to synthetic ETFs, where the counterparty to a swap agreement may pose the risk of defaulting on its agreed obligations. |
Managing risk through diversification
Risk is an inherent part of all investing. However, through informed decision-making this can be managed. A well-constructed, globally diversified ETF portfolio can help you spread risk across many assets, regions and sectors. Diversification can reduce the impact of any single investment performing poorly. This is something our experienced investment team also follows by monitoring risk across all managed portfolios and rebalancing as and when necessary.
ETF fees and charges
Understanding what you pay for when you invest in an ETF is important. Even small differences in costs can have a significant impact on long-term returns.
The three main costs to be aware of:
Cost | What it is | Example |
|---|---|---|
Total Expense Ratio (TER) | Annual cost of holding the ETF (expressed as a percentage of your investment), also known as fund charges | A TER of 0.05% on a £10,000 investment = £5 per year |
Platform and/or dealing fees | Charged by the platform or broker through which you buy the ETF | Varies by provider |
Bid-offer spread | Difference between the price at which you buy an ETF and sell it, at any given moment | A wider spread = higher implicit cost of trading |
Good to know: A low TER does not always mean it is the cheapest overall option. If a fund has a wide bid-offer spread or a low trading volume, the total cost of investing in it can be higher than that of a fund with a slightly higher TER but tighter spread.
How to invest in ETFs in the UK
Investing in ETFs in the UK is straightforward. Here’s a step-by-step process:
Step 1: Choose an account type, typically a Stocks and Shares ISA or a General Investment Account. For many UK investors, an ISA is a tax-efficient starting point.
Step 2: Choose how you wish to invest. You can either opt to select and manage your own investments in ETFs through a self-managed investment platform, or you could opt to invest in a managed investment portfolio where a professional investment team selects and manages a blend of ETFs on your behalf.
Step 3: Consider what you are investing in. If investing by yourself, it is beneficial to understand an ETF’s underlying exposure and how it is built, the costs involved and whether it is income-distributing and/or accumulating. For ETFs with assets outside the UK, you can also look at the currency exposure.
Step 4: Start investing. Once you’ve opened an account and added funds to it, you can make an investment. At this stage, with self-managed investing you can now start to pick and trade the investments yourself. For a managed portfolio, the portfolio manager makes and updates the investment choices for you. Many platforms also offer fractional trading, meaning that you do not need to buy a whole unit of an ETF to get started.
Step 5: Regular reviews are recommended for all investments. Reviewing your portfolio periodically and ensuring that it remains aligned with your financial goals and risk appetite is important.
Want to invest in ETFs without the complexity of choosing them yourself?
Our managed portfolios use a carefully selected blend of ETFs, backed by our experienced investment team.
What's next in the ETF space?
Globally, the ETF market has grown substantially in recent years: assets under management have increased from a little under $4 trillion in 2016 to stand at nearly $20 trillion in March 2026. There are now around 14,500 ETFs available worldwide.*
The graph below shows the global ETF AUM growth over time, across the US and the rest of the world.
Source: J.P. Morgan Asset Management’s Guide to ETFs, data as at 31 March 2026. CAGR stands for compound annual growth rate and reflects the rate at which the global ETF assets under management (AUM) would have grown by between 2016 and 2026 if it had been at a consistent rate, compounded annually.
As the ETF market expands, providers have looked for different ways of maximising the potential of the structure. The ETF market predominantly used to comprise passive ETFs, however, Smart Beta or enhanced indexing soon gained popularity. In recent years, truly active funds have gained significance. J.P. Morgan Asset Management predicts that by 2030, the global fixed income ETF market will grow to $7 trillion, as compared with the current $3.6 trillion AUM*.
*Data as at 30 April, 2026.
The market for active ETFs, in which J.P. Morgan Asset Management is a leader, continues to attract significant investor interest. The graph below shows the active ETF AUM growth over the past decade:
Source: J.P. Morgan Asset Management’s Guide to ETFs, data as at 31 March 2026. CAGR stands for compound annual growth rate and reflects the rate at which the rest of the world and US active ETF AUM would have grown by between 2016 and 2026 if they had grown at a consistent rate, compounded annually.
Risk warning
As with all investing, your capital is at risk. The value of your portfolio can go down or up and you may get back less than you invest. Tax rules vary by individual status and may change. Past performance and forecasts are not a reliable indicator of future performance. This is not investment advice, and always do your own research.