What is an ETP?

The term ETF may be familiar to you, but perhaps not so much the term ETP. In reality, exchange-traded funds are a type of ETP (exchange-traded product). In this article, we will explain what an ETP is, the types that exist, their advantages and disadvantages and how to invest in ETPs.

What is an ETP on the stock exchange?

An ETP is a product tradable on the stock exchange. It stands for “exchange-traded product”.

Exchange-traded products are essentially baskets of financial assets, such as indices, currencies, stocks, and more.

Another characteristic of ETPs is that they are listed on the stock exchange, as their name indicates. This means that they can be bought and sold at any time, like a share, but with the advantage of greater diversification, because it invests in a basket of several assets.

How ETPs work

Although there is more than one type of ETP or product tradable on the stock market, they all share a series of characteristics. What differentiates the ETPs is their structure.

In any case, all ETPs track financial assets. Instead of having to buy the shares of the entire FTSE 100, an ETP allows you to invest in it through a single product and achieve the same return that you would get if you bought the entire index.

The main qualities of all ETPs are:

  • Liquidity. ETPs can be bought and sold at any time of the day.
  • They are listed on regulated markets.
  • They replicate an underlying asset (physically or synthetically).

Types of ETPs

The first ETP was traded in 1989 in the United States and, since then, their number has not stopped growing due to their versatility, reduced costs, and many other benefits

There are three types of ETPs, as discussed next.

ETFs

ETFs are undoubtedly the most well-known type of ETP and also the most widespread. ETFs or Exchange Traded Funds are listed funds. That is, they use the structure of an investment fund to replicate stock indices such as the S&P 500 or FTSE 100, as well as specific sectors (energy, technology, transport…) or specific geographical areas.

The main difference between an ETF and a mutual fund (which does the same) is its structure – an exchange-traded fund can be traded like a stock (at any time during the trading day), while mutual funds can only be bought and sold once, at the end of the trading day, making them less liquid.

Check out our list of the best ETFs and best ETF brokers to find out more about these versatile ETPs.

ETNs

In simple words, an ETN is a security that tracks an index of securities (or benchmark), but its assets are a debenture issued by a bank.

A debenture is a type of bond (debt asset) issued by the bank and it is not backed by physical assets (no collateral, so they only rely on the bank's reputation). An ETF, on the other hand, that tracks commodities may hold them physically or synthetically (via derivatives).

It's important to note that ETNs do not pay interest payments (unlike bonds). Instead, at maturity date, they pay the return of the tracked index.

ETCs

London Stock Exchange provides securities known as ETCs (exchange-traded commodities). In simple words, an ETC is a security that tracks a commodity (or benchmark), but its assets are a debenture issued by a bank.

An exchange-traded commodity is similar to an ETN, but it allows investors to invest in a single market (while ETNs usually track indices).

So, for instance, let's assume you want to invest in gold. If you invest in a gold ETC, you become the owner of a debt note that is backed by an institution (i.e., a bank). In turn, the bank buys the gold as collateral (so they are collateralized, which is different from an ETN, which is not backed by any asset).

The main benefit of investing in an ETC is if you want to obtain exposure to commodities, but don't want to opt for futures trading or options trading as these derivatives are more complicated.

The three types of ETP have common characteristics, but they are different and, above all, pose a different risk. That's why it's important to know the difference between ETFs, ETNs and ETCs.

Why invest in ETPs?

The fact that the popularity of ETPs has grown so much in recent years is no coincidence. Much of their takeoff is due exclusively to ETFs, as more and more investors become familiar with how to choose an ETF that suits their strategy.

From there, ETPs have their own characteristics, advantages and disadvantages that you should evaluate to know if you want to include them in your investment portfolio.

Advantages of ETPs

The strong points of investing in ETPs are:

  • Liquidity. As they work like stocks, they allow for greater liquidity than a mutual fund because you can buy and sell at any time of the day.
  • Diversification (depends on the type of ETP). ETFs can be highly diversified. Some ETFs track the global economy or specific regions, industries, and many more, which makes it easy to achieve diversification benefits.
  • Accessibility. Nowadays, many brokers offer the possibility to invest in or trade ETPs.
  • Reduced costs. When buying an exchange-traded fund, for instance, you invest in a whole basket of assets within a few clicks, which means you don't need to pay fees for each trade separately. Also, this applies in the case of ETNs. ETCs are cheaper than futures or options trading (especially since they are easier to understand and may prevent costly mistakes).
  • Simplicity and transparency. ETPs are a relatively easy product to understand (especially ETFs) and also very easy to buy and sell.
  • Access to many markets. In some cases, ETPs may be the only way to access certain markets. The best example is stocks from certain countries – buying them individually may be very expensive or even not available via your chosen broker.
  • Regulation. ETPs, as they are exchange-traded products, are regulated.

Disadvantages of ETPs

ETPs also have their drawbacks:

  • Past returns do not guarantee future returns: If an ETP has had a good historical performance, it does not imply that in the future it will be profitable, or at least, that it will be as profitable as it has been so far. However, in this sense, it should also be noted that this applies to any investment.
  • Currency risk: This is particularly heightened in the case of ETPs that track foreign markets.

How to invest in ETPs? | Examples

You can use exchange-traded products to design your entire investment portfolio or to complement your existing holdings. Also, they are useful to achieve diversification benefits quickly or to track an entire market or sector.

So, for instance, let's assume you want to invest in gold. Many people avoid investing in gold physically due to security risks, storage issues, maintenance, liquidity, and many more. With ETPs, you have a few options:

  • Choose one of the best ETF brokers to invest in a gold ETF, such as SPDR Gold Shares ETF.
  • Invest in ETNs like iPath Bloomberg Commodity Index Total Return ETN with a world-renowned broker like Interactive Brokers (Interactive Brokers review).

There the offer of ETFs when it comes to the stock market is overwhelming. For example, you can invest in the whole world with an ETF that replicates an index like the MSCI Word Index or in the technology sector through the iShares S&P 500 Information Technology Sector ETF.

There are even ETFs that cover more specific areas and themes such as the VanEck Vectors Gaming ETF (BJK) which invests in the gaming sector or the Global X S&P 500 Catholic Values ETF, which invests in companies that are governed by Catholic values.

Summary

Whether you are interested in investing in commodities or buying stocks online, ETPs are very useful. These exchange-traded products are relatively new, but there are many benefits to be considered, such as lower costs, liquidity, and accessibility.

FAQs

How do ETPs differ from traditional mutual funds?

ETPs differ from traditional mutual funds in that they are traded on stock exchanges throughout the trading day, like individual stocks. Mutual funds, on the other hand, are typically bought and sold at the end of the trading day at the net asset value (NAV) price. ETPs offer more intraday liquidity and transparency.

Are ETPs suitable for long-term investments or better for short-term trading?

ETPs can be suitable for both long-term investments and short-term trading, depending on the specific ETP and your investment goals. Some ETPs are designed for long-term investors seeking exposure to diversified portfolios, while others are structured for short-term trading strategies, like leveraged or inverse ETPs.

What risks are associated with investing in ETPs?

ETPs come with various risks, including market risk, tracking error risk (for ETFs), credit risk (for ETNs), and liquidity risk. Additionally, leveraged and inverse ETPs can amplify risks, making them more suitable for experienced and risk-tolerant investors.

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