Last updated on April 7th, 2022 , 06:43 am
Exchange-traded products (ETPs) allow investors access to securities without having to directly invest in those securities. These securities include, but are not limited to 1.) baskets of stocks 2.) debt instruments 3.) individual or baskets of commodities.
This article is going to explore and compare a few of the more popular exchange-traded products. All products on our list are exchange-traded, meaning you can trade them with your broker on stock exchanges.
Let’s start off with a brief description of the various ETPs we will be exploring and comparing in this article:
1.) ETP (Exchange-Traded Product)
All of the securities on our list fall under the ETP (exchange-traded product) umbrella.
2.) ETF (Exchange-Traded Fund)
ETFs are the most popular and generally the most liquid of products of all ETPs. An ETF is a basket of securities that tracks an underlying index, typically composed of stocks.
3.) ETN (Exchange-Traded Note)
ETNs are bank-issued unsecured debt securities. ETNs track an underlying index without owning the underlying asset.
4.) ETC (Exchange-Traded Commodity)
ETCs are exchange-traded products that track and fluctuate with the price of a commodity or a basket of commodities. ETCs are most common in Europe.
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What is an ETP (Exchange-Traded Product)?
- ETPs track securities on a wide array of securities, such as stocks, bonds, cryptocurrencies, normal currencies and commodities.
- ETPs trade on exchanges just as stocks do.
- ETPs generally provide investors with a more cost-efficient alternative to mutual funds.
- The value of ETPs is in constant flux with the market.
Exchange-Traded Products (ETPs) Definition: ETPs are financial products that trade on public exchanges that give investors exposure to a wide array of securities.
All funds on our list (ETFs, ETNs, and ETCs) are considered exchange-traded products.
These funds have been exploding in popularity. Why? ETPs offer investors a simple and low-cost way to diversify their portfolios. Some ETPs funds offer investors access to thousands of underlying stocks!
Unlike mutual funds, ETPs trade actively during market hours. You can buy and sell ETPs at any time of the day. These funds can even be traded when the market is closed when using the EXT TIF order type.
This is unlike mutual funds, which can only be open and closed at one point of the day. Additionally, the fill price you receive on mutual funds is unknown. With ETPs, you can use specific order types, such as a limit order, stop-limit order, and stop-loss order.
The most popular ETP is the ETF. Let’s take a look at exchange-traded funds next!
What is an ETF (Exchange-Traded Fund)?
- ETFs trade on an exchange and can be purchased and sold just like stocks can.
- ETFs cover a wide spectrum of investments, which include domestic stocks, international stocks, commodities, and bonds.
- ETFs are growing in popularity among long-term investors due to their low cost, high liquidity nature.
Exchange-Traded Fund (ETF) Definition: ETFs represent a basket of securities investors can buy or sell through a brokerage firm.
The vast majority of ETPs are ETFs. According to Business Insider, 97% of the $5 trillion global ETP market consists of exchange-traded funds.
So how do ETFs work? For an in-depth analysis, check out our article “ETFs Explained: Investing Basics”.
In a nutshell, here’s how ETFs work:
How Are ETFs Created?
- An ETF issuer creates a fund that holds the underlying securities.
- The fund is broken down into individual shares which smaller individual investors can buy and sell.
- These shares are listed on an exchange and actively traded.
After an ETF is listed, authorized participants are called upon to keep the value of the ETF in line with that of the underlying basket of securities. If the fund is trading above its NAV (net asset value), these participants will purchase shares of the individual securities that constitute the fund to bring their value in line with the ETF.
So how many types of ETFs are there? A lot! Here are a few of the more popular fund types.
Types of ETF Asset Classes
- Stock (Equity) ETFs
Stock market ETFs are created to track equity sectors and indices. The most popular of all ETPs is State Street’s SPY ETF. SPY is an index fund that tracks the performance and yield of all 500 stocks within the S&P 500 benchmark index. They do this for the low expense ratio (fee) of 0.09%
- Bond ETFs
Bond ETFs provide investors with a regular source of income. Bond ETFs are less concerned with price appreciation for this reason. When purchasing bond ETFs, always look at the yield before looking at the ETFs’ historical performance!
- Commodity ETFs
Commodity ETFs invest in physical commodities. These can include oil, gold, currencies and precious metals.
Unlike other ETFs, commodity ETFs generally only invest in a single commodity. Because of this lack of diversification, you may be wondering why these products are called “funds” at all. Some countries don’t consider these products’ ETFs for this reason, but ETCs (exchange-traded commodities). More on this to come!
Commodity ETFs can either 1.) hold the actual physical commodity or 2.) hold futures contracts that track the performance of that commodity.
When tracking commodities via futures contracts, commodity ETFs can deviate greatly from the “spot” price of the actual commodity. This is called “contango” and “backwardation”. You’ve been warned!
- Cryptocurrency ETFs
Cryptocurrency ETFs are the newest ETPs on our list. The most popular crypto ETF is BITO by ProShares. This is a bitcoin-linked ETF that tracks the coin via futures contracts. Refer to our above caution box to see why this may be a bad idea!
If you’d like to learn more about Proshares BITO ETF check out our article, “ProShares BITO ETF Explained“.
- Leveraged ETFs
Leveraged ETFs provide investors with leveraged exposure to an underlying commodity or basket of securities. Leveraged ETFs use opaque “swap” contracts to achieve this leverage. The greater the leverage, the greater the tracking error and risk. The below image (from Tony Cooper) shows the historical return of various leveraged products over a long duration. Leveraged ETFs are not designed for long-term investors.
Some of the more popular leveraged ETFs include:
- SPUU (Direxion Daily S&P 500 Bull 2X Shares ETF)
- UPRO (The Direxion Daily S&P 500 Bull 3x ETF)
- QLD (ProShares Ultra QQQ 2x ETF)
- TQQQ (Proshares Ultra QQQ 3x ETF)
Learn more about leveraged ETFS in our video below!
Additionally, ETFs can be options-based. Options trading (specifically covered call writing) can provide investors with extra income – and risk!
Read: 7 Covered Call ETFs and How They Work
What is an ETN (Exchange-Traded Note)?
- ETNs are unsecured, bank-issued debt securities that trade on exchanges just as stocks do.
- ETNs are similar to bonds in structure with the exception ETNs do not pay dividends, so there are no distributions to tax.
- At the maturity date, ETNs pay the value of the index minus any fees.
Exchange-Traded Note (ETN) Definition: ETNs are unsecured debt securities that track an underlying index. Issuer risk is present in ETNs.
Exchange-traded notes are a bit more nebulae than ETFs. Perhaps the greatest distinction lay in their constitution. ETNs, unlike ETFs, do not actually own the securities of the index it tracks.
Instead, through various financial instruments, ETNs simply pay the return of a specific index. With no actual security base, ETNs behave more like bonds.
Since there are no underlying securities held, the health of ETNs is contingent upon the health of the issuing financial institution. Therefore, the credit rating of the issuer is of utmost importance in determining an ETNs credit risk.
Some of the more popular ETNs include market volatility products related to the VIX index include Barclays iPath Series B S&P 500 VIX Short-Term Futures ETN (VXX) and ProShares Ultra VIX Short Term Futures ETF (UVXY). During the financial crisis, many volatility products imploded.
What is an ETC (Exchange-Traded Commodity)?
- ETCs (exchange-traded commodities) are the European equivalent of American single commodity-based ETFs.
- ETCs are most similar to ETFs and are settled in the same fashion.
Exchange-Traded Commodity (ETC) Definition: ETCs (most common in Europe and Australia) are bank-issued securities that track a single commodity.
We covered earlier the various exchange-traded funds (ETFs) that track commodities.
In Europe and Australia, these types of funds are called exchange-traded commodities (ETCs).
Why? The regulatory bodies of these countries do not believe these types of products should be called “funds” due to their lack of diversification.
Like American commodity ETFs, ETCs can be linked to a commodity through its spot price or via the futures market. As we said before, products that are linked via futures have more risk than those linked via the spot market.
Let’s take a closer look at the differences between ETFs and ETCs next, then finish the article by comparing all 3 types of funds on our list.
Exchange-Traded Fund (ETF) vs Exchange-Traded Commodity (ETC)
ETF vs ETC: Regulation and Nomenclature
- ETCs fall under the EU’s directive UCITS (Undertaking for Collective Investment in Transferable Securities), which requires funds with exposure to only one commodity be deemed an “ETC”, or exchange-traded commodity. ETCs that contain a basket of commodities can indeed be called an ETF under this ruling.
- In the United States, commodity ETFs are regulated by the Commodities Futures Trading Commission (CFTC). The CFTC allows commodity funds to be called “ETFs” even when that fund invests in a single commodity.
ETF vs ETC: Risk Exposure
- Commodity ETFs invest directly in a commodity, either via the spot market or futures contracts, and have market risk.
- Exchange-Traded Commodities (ETCs) are debt securities issued by banks and therefore have default and market risk.
ETF vs ETN vs ETC: What's The Difference?
| ETF (Exchange-Traded Fund) | ETN (Exchange-Traded Note) | ETC (Exchange-Traded Commodity) | |
|---|---|---|---|
|
Asset Category |
Broad |
Unsecured Debt |
Commodity |
|
Risk |
Market Risk |
Market Risk; Issuer Risk |
Market Risk; Issuer Risk |
|
Liquidity |
Most Liquid |
Less Liquid |
Less Liquid |
|
Tracking Error |
High |
Low |
Low |
|
Dividends |
Usually Yes |
No |
No |
|
Tax Treatment |
Short or Long-Term Capital Gains Tax. |
Short or Long-Term Capital Gains Tax. |
Varies |
ETF vs ETN vs ETC: FAQs
Though both ETFs and ETNs have similarities, they are structurally different. ETFs provide investors direct exposure to securities while ETNs are unsecured debt securities that track an underlying index without owning the underlying.
In addition to market risk, exchange-traded notes are subject to issuer risk. ETNs are as safe as the bank that issues them. When trading ETNs, make sure the issuing financial institution has a high credit rating.
ETNs offer investors the benefit of access to hard-to-reach markets and accurate tracking performance. ETNs also do not issue dividends, so no tax is paid on dividends.
Exchange-traded commodities (ETCs) are not considered funds in the eyes of the European Union because they are not diversified.
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