Exchange Traded Products (ETPs) are a collective term to describe investments that normally follow the underlying securities or assets, but they can also be actively managed.
There are three types of ETP: Exchange Traded Funds (ETF), Exchange Traded Commodities (ETC) and Exchange Traded Notes (ETN). They are all listed and traded throughout the day on the stock exchanges just like stocks.
The price of an ETP will vary depending on the value of the underlying investment. They are generally used by investors as inexpensive alternatives to active funds, but that does not mean that they are suitable for all investors.
Below, we take a closer look at the three types of TVEs, the differences between them, and which ones might be right for you.
This article is not personal advice. If you are not sure whether an investment is right for you, seek financial advice. All the investments and the income from them can go down as well as up, so you might get back less than what you invested.
AND F
An ETF is a basket of investments that typically includes stocks and bonds. Their price can rise and fall depending on their underlying holdings. If they follow an index like the FTSE 100 or the S&P 500, they are said to be passive.
ETFs tend to be associated with passive investments and lower fees, although this is not always the case. They can be performed in several ways, including:
- Physically replicating ETFs, which buy the basket of index investments.
- Synthetic Track ETFs, which use derivative contracts to track the index. Synthetic replication typically reduces costs and tracking error, but comes with counterparty risk. It is the likelihood that the other party to a transaction will not fulfill its end of the deal and default on its contractual obligations.
- Smart Beta ETFs, which follow alternative strategies as opposed to market-capitalization weighted indices, where large companies make up a larger proportion of the index. They are often a mixture of passive and active.
- Active ETFs, where managers attempt to beat the performance of a benchmark by buying specific investments.
ETC
ETCs provide a way to track the performance of a commodity or commodity index for markets like oil, precious metals, natural gas, and livestock.
Commodities attract investors because they can often move in the opposite direction to stocks and bonds. This means they could rise when stocks fall and vice versa. While this is not always the case, they can provide shelter for investors if stock or bond prices fall.
An ETC can use either a physical approach to buying the underlying investments or futures contracts. Futures contracts allow their holder to receive the underlying investment, such as a barrel of oil, at a set price, location, and date in the future. Using an ETC means that investors do not have to own physical stocks like gold bars or a barrel of oil themselves.
They differ from ETFs in that they use the commodity as collateral for the investment which is purchased using the cash inflows into the ETC. This provides an additional layer of security for investors in case something happens to the issuer of the investment.
Physically supported ETCs are physically secure. For example, gold bars are stored in a bank or in the treasury as collateral. This eliminates the risk of issuing the ETC. However, storing the asset can also add costs and weigh on returns for investors.
AND N
ETNs use debt securities issued by banks or investment firms to track the performance of an index. ETNs are like bonds in that investors receive the return of their originally invested amount at maturity.
However, unlike bonds, ETNs do not pay interim interest. ETN investors also do not own the securities they follow. This means that the probability of being reimbursed for the principal and returns on the investment depends on the creditworthiness of the issuer of the ETN (the bank or the investment company).
Assuming there is no problem with the issuer, investors can expect the principal payment and return received from the index they are tracking on the maturity date, less any fees or commissions. .
Which one might be right for you?
Diversification through an asset pool is the key to a healthy and well-balanced portfolio. That said, ETPs and their various options are not for everyone. ETFs give investors the opportunity to invest in larger equity or bond markets and are therefore more popular. ETCs and ETNs are normally used to meet more specialized investment needs.
That said, FTEs are only one option. Investors should only invest if the investment objectives are aligned with their own and the type of investment being made is specifically necessary. Investors should understand the specific risks before investing and ensure that any new investment is part of a diversified portfolio.
If you are looking to invest in ETPs, don’t forget to consider the transaction costs as well.
To learn more about ETPs, visit our Help and Support page.
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