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Exchange Traded Products – what are your options?

There’s an array of Exchange Traded Products (ETP) available to investors. But what are they and what’s the difference?

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Exchange traded products (ETPs) is a collective term for describing investments that normally track underlying securities or assets, however they can also be actively managed.

There are three types of ETP: Exchange Traded Funds (ETFs), Exchange Traded Commodities (ETCs) and Exchange Traded Notes (ETNs). They’re all priced and traded throughout the day on exchanges, just like shares.

The price of an ETP will vary depending on the value of the underlying investment. They’re typically used by investors as low-cost alternatives to active funds, but that doesn’t mean they’re right for all investors.

Below, we take a closer look at the three types of ETPs, the differences between them and which could be right for you.

This article isn’t personal advice. If you’re not sure if an investment is right for you, ask for financial advice. All investments and any income from them can fall as well as rise in value, so you could get back less than you invest.

ETF

An ETF is a basket of investments that usually includes shares and bonds. Their price can rise and fall in line with their underlying holdings. If they track an index like the FTSE 100 or S&P 500, they’re known as passive.

ETFs tend to be associated with passive investing and lower fees, though that’s not always the case. They can be run in a number of ways, including:

  • Physically replicated ETFs, which buy the basket of investments of the index.
  • Synthetically replicated ETFs, which use derivative contracts to replicate the index. Synthetic replication generally reduces costs and tracking error, but comes with counterparty risk. This is the probability that the other party in a transaction might not fulfil its part of the deal and default on their obligations of the contract.
  • Smart Beta ETFs, which follow alternative strategies as opposed to market capitalised weighted indices, where larger companies make up a bigger proportion of the index. They’re often a blend of passive and active.
  • Active ETFs, where managers try to beat the performance of a benchmark index by buying specific investments.

ETC

ETCs offer a way to track the performance of a commodity or commodity index for markets like oil, precious metals, natural gas, and livestock.

Commodities appeal to investors as they can often move in the opposite direction to shares and bonds. This means they could go up when shares fall and vice versa. While this won’t always be the case, they can offer investors some shelter if shares or bonds prices fall.

An ETC can use either a physical approach of buying the underlying investments or futures contracts. Futures contracts entitle the holder to receive the underlying investment, like a barrel of oil, at a set price, location, and a set date in the future. By using an ETC, it means investors don’t have to hold physical stock themselves like gold bars or a barrel of oil.

They differ from ETFs as they use the commodity as collateral for the investment which is purchased using the inflows of money into the ETC. This offers an extra layer of security for investors in case anything happens to the issuer of the investment.

Physically backed ETCs are physically secured. For example, gold bars are stored in a bank or the treasury as security. This helps eliminate the issuer risk of the ETC. However, storing the asset can also add costs and weigh on the returns to investors.

ETN

ETNs use debt securities issued by banks or investment companies to track the performance of an index. ETNs are like bonds in that investors receive the return of their original invested amount at maturity.

However, unlike bonds, ETNs don’t pay interim interest payments. Investors of ETNs also don’t own the securities they track. This means the likelihood of being paid back the principal payment and returns from the investment relies on the creditworthiness of the ETN issuer (the bank or investment company).

Assuming there are no issues with the issuer, investors can expect the principal payment and the return received from the index they track at the maturity date, less any fees or commissions.

Which could be right for you?

Diversifying across a pool of assets is key to a healthy, well balanced portfolio. That said, ETPs and their various options aren’t right for everyone. ETFs give investors an opportunity to invest in broader shares or bond markets and as such are more popular. ETCs and ETNs are normally used to fit more niche investing needs.

That said ETPs are only one option. Investors should only invest if the investments’ objectives are aligned with their own, and there's a specific need for the type of investment being made. Investors should understand the specific risks before they invest, and make sure any new investment forms part of a diversified portfolio.

If you’re looking to invest in ETPs, remember to also consider dealing charges.

To learn more about ETPs, visit our Help & Support page.

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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