Differences between ETF, ETC, and ETN: key nuances for passive investment strategies

As investors increasingly place their trust in passive management as an alternative to active management for long-term wealth growth, understanding the distinctions between various Exchange-Traded Products (ETPs) has become a pressing question. Specifically, investors are seeking clarity on the dissimilarities between ETFs, ETCs, and ETNs.

ETFs, or Exchange-Traded Funds, are one category of ETPs that have garnered significant popularity. ETCs, on the other hand, represent another class, and then there are ETNs, offering a diverse range of investment principles tailored to meet specific goals.

In this article, we will delve into the contrasts among these ETPs, shedding light on their unique features and guiding investors in making informed decisions about their investment strategies.

What is an ETP?

The ETPs or Exchange Traded Products are financial products that are traded on the stock market of a country (or more than one). Generally, ETPs follow an index, a raw material or a currency, and its price is determined by the quotation they have on the stock exchange, so it will be available at any time of the day during the trading day. The main types of ETPs are ETFs, ETC, and ETN.

What is an ETF?

Exchange-Traded Funds (ETFs) are a type of asset that pools investors’ funds to invest in a diversified basket of assets. The strategy of a fund may vary significantly – some track indices, others may track entire industries or sectors, or even entire economies.

Another important feature is being tradable like ordinary shares on the stock exchange. As a result, ETFs are continuously quoted on the market, allowing investors to buy or sell shares at any time during the trading day.

Classification of ETFs

ETFs can be:

  • Direct ETFs: they invest in assets according to the predetermined strategy and objectives.
  • Inverse ETFs: Inverse ETFs mimic the opposite behaviour of the reference index or market. This means they offer a return when the market declines, making them a suitable option for profiting in unfavourable market conditions. They can also serve as a hedge during specific market circumstances.
  • Leveraged ETFs: These ETFs magnify the exposure to the reference index or market, sometimes doubling or tripling it. While they have the potential for greater returns, they also carry higher risks.

Moreover, ETFs can be categorised based on how the assets they hold:

  • Physical ETFs: these funds hold actual assets (i.e., stocks or other assets).
  • Synthetic ETFs: these funds use derivatives instead of actual assets, such as swaps.

Advantages and disadvantages of ETFs

ETFs offer several advantages that make them an attractive investment option. One of their key strengths lies in their low cost, ensuring that investors achieve returns closely aligned with the benchmarks, thanks to minimal tracking errors.

ETFs are a cost-effective way of diversifying your investment portfolio. You can invest in an ETF similar to stocks, but they allow you to invest in a professionally-managed fund with diversified holdings at a fraction of the cost associated with investing in each asset individually. Also, since they are managed by a professional fund manager, it is ideal for passive investors or beginners alike.

ETF managers

Among the world’s largest ETF managers are renowned names such as Vanguard, Fidelity, iShares, Amundi, DWS Asset Management, and Lyxor Asset Management. Notably, Global X ETFs has emerged as a pioneering force in thematic ETFs, presently ranking among the top 10 issuers.

What is an ETC?

An Exchange Traded Commodity (ETC) is a variant of an ETF specifically designed to replicate the behaviour of commodities like gold, silver, oil, and others.

ETCs typically carry a high level of risk due to the inherent volatility associated with raw materials, such as metals and various forms of energy.

Classification of ETCs

ETCs can be categorised into two main types:

  • Physical: These ETCs directly purchase the physical raw material, thereby avoiding credit risk.
  • Synthetic: Synthetic ETCs use derivatives to gain exposure to raw materials, introducing some degree of credit risk and counterparty risk.

Differences and similarities between ETCs and ETFs

ETCs and ETFs share the characteristic of being traded on exchanges, allowing continuous trading throughout the trading session.

The main difference is that ETFs usually invest broadly over many securities, while ETCs provide exposure to commodities only (usually one single commodity). If you are interested in commodity trading, check out our guide on futures trading as well.

What is an ETN?

An Exchange Traded Note (ETN) is an unsecured debt security. The ETN tracks an underlying index of securities and trades on exchanges, just like stocks. In addition, an ETN is issued by a financial institution and is a type of bond – however, an ETN does not have interest payments and its return is based on an index it tracks.

When the ETN reaches maturity, the institution that issued it takes its portion of the fees and returns the invested cash to the investor based on the performance of the tracked index.

Differences and similarities between ETNs and ETFs

In an ETF, the fund owns the securities in the tracked index. However, ETNs do not provide ownership rights, the investors in the ETNs are simply paid the return produced by the index.

ETNs are the most complex among these three products, demanding careful consideration due to the variety of risks that do not exist in ETFs or ETCs, such as default risk (i.e., the issuer is not able to pay the investors upon maturity).

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ETFs vs ETCs vs ETNs: conclusions

Although these three products share similarities in their operation, they possess unique characteristics that cater to different investor profiles and strategies.

Currently, active management’s usefulness is under scrutiny, and ETPs are gaining significant traction. Their low costs and ease of purchase can be advantageous for many investors.

However, it’s essential to consider costs and taxation implications before investing in any product or asset, depending on your personal circumstances. Overall, ETPs offer compelling alternatives for investors seeking diverse investment options.

ETFs vs ETCs vs ETNs: FAQs

What are the primary advantages of investing in ETFs?

ETFs offer investors the benefit of low costs, diversified portfolios mirroring market indices, and real-time tradability, making them an attractive option for long-term wealth growth.

What distinguishes ETCs from ETFs, and what risks should investors be aware of?

ETCs are exchange-traded commodities that replicate the behaviour of raw materials, but unlike ETFs, they may carry higher risk due to the volatility of commodities and potential credit risk from derivative use.

How do Exchange Traded Notes (ETNs) differ from other ETPs?

ETNs are unsecured debt instruments issued by financial entities, linked to underlying assets, but the credit risk of the issuer and other factors like liquidity impact their results.

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