An exchange-traded product (ETP) is a financial asset that is openly traded on the stock market, similar to a bond.
ETPs provide exposure to an increasing variety of asset classes, allowing investors to diversify their holdings.
Below are the types of exchange-traded products.
Exchange-traded funds (ETFs)
ETFs are a form of exchange-traded investment vehicle that, under the 1940 Act, must be registered with the SEC.
Unlike mutual funds, ETF shares are traded on a national stock exchange at market prices that may or may not reflect the shares’ net asset worth.
ETFs, in general, combine the qualities of a mutual fund. This may be acquired or redeemed at the end of each trading day at its NAV per share, with the intraday trading feature of a closed-end fund, whose shares trade at market prices throughout the trading day.
Types of ETFs
Diversified passive equity exchange-traded funds (ETFs) are meant to replicate the performance of popular stock market benchmarks such as the S&P 500, Dow Jones, and MSCI Europe Australasia Far East (EAFE) indexes in real-world markets.
To assist investors in fine-tuning their portfolio strategy, niche passive equity funds replicate the S&P 500 or Russell 2000. These specialty portfolio funds, like diversified passive funds, are usually composed of the same equities that comprise their reference indexes.
Active equity ETFs allow managers to exercise their own discretion in picking assets rather than being bound by a benchmark index. Active ETFs may exceed a market benchmark, but they also involve greater risk and higher fees. Some ETFs focus on fixed-income bonds instead of equities.
How do ETFs work?
ETFs are intended to mirror the underlying asset value or index value. They trade at prices established by the market, which vary from the value of the item.
Long-term returns for an ETF differ due to costs and other variables from those of its underlying asset.
Exchange-traded commodities
An ETC records a specific commodity or commodity basket on its commodity exchange. An ETC tracks a particular commodity.
Just like a stock share, the share price of an ETC might likewise change during the day according to the commodity it tracks.
An ETC’s performance is linked to one of two sources. It might be based on the spot price of a commodity or the price of a futures contract.
The net asset value (NAV) of each ETC is regarded as the fair value of each share. Because shares are traded on an exchange, their market value may fluctuate.
The issuer just purchases the equivalent quantity of actual gold and stores it safely for each ETC unit. Full collateralisation is achievable for some assets, such as oil ETCs, using loan collateral or very high credit ratings.
Because values are continuously changing, this “swap-based” collateralisation generally necessitates daily assessment and modification.
Third-party coverage is another type of swap-based collateralisation. However, the ETCs thus secured are vulnerable to the default risk of the third party, which is often a bank or corporation.
Benefits and features of exchange-traded commodities
- Despite the fact that it is a debt instrument, the ETC is reasonably secure. The issuer offers collateral, which might be in the form of the commodity being tracked or investments in other high-quality assets.
- When an investor purchases shares in an ETC, they are not purchasing the real commodity. This eliminates the need for them to worry about storing the commodity. Consider how difficult it would be to explain all of the livestock to your neighbor.
- An ETC is managed passively by the fund management. When compared to other actively managed funds, this immediately results in a reduced management charge, also known as the expense ratio.
Exchange-Traded Notes (ETNs)
ETNs are bonds that are issued by a bank or another financial institution. ETNs offer to pay investors the return on an index over a specified time period and to repay the investment at maturity.
If the firm fails, ETN investors may be left with a worthless investment or one worth significantly less.
ETNs, unlike ETFs, do not have a board of directors. Instead, the issuer is exclusively responsible for the management of an ETN.
In some circumstances, issuers may engage in proprietary trading or hedging operations that are detrimental to ETN investors’ interests.
ETNs do not pay interest in the same way that bonds do. Investors profit from the difference between purchasing and selling rates since ETNs trade on key markets such as futures.
Exchange-traded notes do not offer investors ownership of the assets. As a result, ETNs are comparable to debt products.
Investors must expect that the issuer will be able to generate a profit based on the underlying index.
Characteristics of ETNs
- The underlying assets of the indexes are not owned by an exchange-traded note; rather, it tracks them. The ETN, for example, tracks the gold index but does not purchase gold.
- The creditworthiness of the investor and the issuer’s pledge to return the original investment are important considerations when deciding whether to buy or sell an ETB.
- On trading days, exchange-traded notes (ETNs) can be exchanged through the exchange or directly with the issuing bank. Early redemption is usually done on a weekly basis and comes with a redemption charge.
- Most financial products, including exchange-traded notes (ETNs), have an annual cost ratio. The expense ratio is the fee charged by the fund manager to cover fund management and associated expenditures.
Benefits of ETNs
- Investors do not get monthly dividends or interest payments, nor do they receive capital gains distributions throughout the year. Instead, any profit (or loss) is postponed until the ETN is sold or matures.
- The underlying asset of the exchange-traded note (ETN) is not owned by the ETN. As a result, unlike an exchange-traded fund, no rebalancing is necessary. The ETN duplicates the value of the index or asset class that it follows.
- ETNs can be purchased or sold during normal trading hours on the securities market, or they can be returned to the issuing bank on a weekly basis. Investors can track the performance of the debt instrument in the same way that they would a stock investment.
Conclusion
The stock market provides investors with numerous ways to achieve their investment objectives. Investors can tailor their market exposure using various derivatives, funds, and debt instruments. Before investing in any asset, make sure you understand how they work and what risks are involved.
