ETP vs. ETF: The Differences in Exchanged-Traded Offerings
Are you weighing your options between an exchange-traded product (ETP) and exchange-traded fund (ETF) for your investment portfolio? In sum, an ETF is a subset of ETPs, offering real-time pricing and the flexibility of stock-like trading, making it a highly liquid asset class. Our guide zeroes in on ETPs and ETFs to examine their differences, structures and the way they fit into diverse investment strategies.
Key Takeaways:
ETPs and ETFs are exchange-traded offerings with differing structures, regulations and liquidity. ETFs are a type of ETP, with distinct features such as intraday liquidity, and are usually more popular for their trading flexibility and lower costs.
There are various ETPs, including ETFs, ETNs, ETMFs and ETCs, each with unique risks and structures tailored to different asset classes. ETFs generally offer greater diversification, and are regulated with investor protections under the Investment Company Act of 1940.
Investors must consider factors such as cost, risk tolerance and desired market exposure when choosing between ETPs and ETFs. ETFs typically appeal to those seeking lower risk and cost, while ETPs, such as leveraged or inverse products, cater to higher-risk strategies.
Understanding ETPs and ETFs
ETPs and ETFs have emerged as major players in online investing platforms. Below, this article analyzes the two financial instruments.
Some basic info about ETPs:
ETPs are investment funds that are traded on stock exchanges.
As financial instruments, ETPs track underlying indices, commodities or assets.
They offer convenience for trading and access to a wide range of asset classes.
As a type of ETP that possesses distinct characteristics (unlike mutual funds), ETFs:
are traded like stocks on an exchange
resemble mutual funds in their pooled investment structure
provide intraday liquidity and real-time pricing information
These features make ETFs popular among investors.
Investors consider allocating funds to ETFs due to their high liquidity. They can be traded throughout the day, much like stocks, offering investors a level of flexibility thatâs hard to match.
What Are ETPs?
ETPs (exchange-traded products) resemble a âmixed bag of candiesâ in that they include a wide array of investment products, such as:
Exchange-traded funds (ETFs)
Exchange-traded notes (ETNs)
Exchange-traded managed funds (ETMFs)
Exchange-traded commodities (ETCs)
Each category of ETP has distinct characteristics and structures tailored to different asset classes and investment strategies. Investors can use ETPs as a convenient tool for diversifying their portfolios. These financial instruments provide a simple way to access a wide range of investment options.
ETNs, for instance, carry various risks, including credit risk linked to the issuerâs financial stability. They also feature call risk, which could result in potential loss if the issuer recalls the ETN. However, the returns on ETNs are typically tied to the performance of an underlying index or benchmark (after deducting any fees). This means that ETNs can provide investors with exposure to indices and potentially offer attractive returns.
What Are ETFs?
ETFs (exchange-traded funds) hold a diversified portfolio of investments, generally reflecting an underlying index of investments such as stocks or bonds. Investors buy and/or sell shares of the ETF on an exchange, similarly to the trading process for stocks. Exchange-traded funds can include a variety of investments, such as:
Stocks
Commodities
Bonds
Crypto
A combination of the above
ETFs offer diversification and flexibility for investors. Passively managed ETFs are designed to replicate the performance of an index or sector, offering cost-effectiveness and transparency.
ETFs have several advantages over mutual funds, including the following:
Theyâre traded on stock exchanges during trading hours, offering investors the benefit of intraday liquidity.
ETFs deliver the crucial ability to trade without causing substantial impact on price.
They can either be actively or passively managed, each approach with its own impact on the expense ratio.
Unlike mutual fund trades, which are executed at the end of the trading day, ETFs can be bought and sold throughout the trading day.
ETPs vs. ETFs
Having examined ETPs and ETFs separately, itâs time to compare them. While both ETPs and ETFs are exchange-traded offerings that provide investors with exposure to various asset classes, they differ in structure, regulation and trading characteristics. ETPs are traded on exchanges in a manner similar to trading stocks, and they can encompass exchange-traded commodities (ETCs) that provide exposure to commodities through shares. On the other hand, ETFs are collections of securities that follow underlying indexes, and may include investments such as stocks and bonds.
When it comes to liquidity, ETFs typically exhibit superior characteristics as compared to ETPs, making them more preferable and expedient for investors. Along with their trading flexibility, portfolio diversification, risk management, lower costs and tax benefits, this contributes to the greater popularity of ETFs when compared to ETPs.
Structure and Regulation
The majority of ETPs are structured as ETFs, which are registered with and regulated by the SEC as investment companies under the Investment Company Act of 1940 in terms of their structure and regulation. This provides investors with a level of oversight and transparency. ETFs typically concentrate their investments in stocks, bonds or debt securities, and are subject to diversification requirements. Theyâre traded on the stock exchange, providing investors with liquidity and flexibility.
However, there are differences in regulatory oversight between ETFs and other ETPs, such as ETNs. ETFs must comply with regulations of the Investment Company Act of 1940, and are subject to stringent oversight, including supervision by a board of directors and the Financial Industry Regulatory Authority (FINRA).
ETNs, on the other hand, donât feature board oversight, which indicates a less rigorous regulatory framework.
Trading and Liquidity
While both ETPs and ETFs have a presence on stock exchanges, ETFs typically provide higher liquidity and narrower bid-ask spreads. This higher liquidity of ETFs as compared to ETPs is primarily influenced by the composition and trading volume of the securities that make up each ETF, along with the trading volume and investment environment.
The bid-ask spread can vary for ETPs and ETFs. However, itâs a crucial aspect for ETFs, as they trade similarly to single stocks, making spreads more pertinent. ETFs with high popularity and strong trading volume usually result in narrower bid-ask spreads, but less popular ETFs, or those with highly illiquid underlying securities, may experience wider spreads.
Diversification and Risk Management
ETFs and ETPs allow for diversification and risk management. However, the level of diversification might depend upon the specific product and its underlying assets.Â
As an example, ETCs provide access to commodities, whereas ETFs such as iShares Core ETFs enable investors to construct well-rounded portfolios for long-term objectives. ETFs generally follow a range of underlying assets, offering more extensive diversification as compared to certain ETPs that may focus on particular industries or commodities.
A lack of diversification in ETFs and ETPs can result in heightened exposure to specific sectors, which can be detrimental during a downturn in that sector. Additionally, leveraged or inverse ETFs may encounter tax inefficiencies due to daily resets, which could potentially lead to taxable gains or losses.
Types of ETPs and ETFs
A myriad of market options cater to different investment strategies, including passive vs. active management, sector and industry focus, and leveraged and inverse products. Passive ETFs are designed to replicate the performance of an index or sector. They offer advantages such as cost-effectiveness and transparency, making them a favorable choice for investors inclined toward a passive investment approach.
Active ETFs, on the other hand, are overseen by experienced professionals, with the objective of surpassing a benchmark index. In contrast to passive ETFs, active ETFs utilize diverse investment strategies and can adjust portfolio allocation in response to market conditions.
Passive vs. Active
Within the realm of ETPs and ETFs, passive strategies and active strategies offer distinct approaches to investing.
Passive ETPs and ETFs:
Track an underlying index
Are typically less expensive and more tax-efficient than their active counterparts
Offer a low-cost way of gaining exposure to a wide range of investments
On the other hand, active ETPs and ETFs have the following characteristics as well:
They employ portfolio managers to make investment decisions.
These products aim to outperform the market, offering potential for higher returns but also carrying higher risk and cost.
The performance of active ETPs and ETFs is impacted by the proficiency and expertise of portfolio managers, along with external factors including market liquidity, trading volume and the broader investment landscape.
Sector and Industry Focus
ETFs and ETPs offer targeted investment opportunities in specific market segments, which can be broadly categorized into sectors and industries. While these terms are often used interchangeably, there's a subtle difference:
Sector ETFs: These ETFs focus on a broader category of the economy, encompassing a range of industries. For example, a sector ETF might target the financial sector, including industries like banking, insurance, and real estate. Sector ETFs allow investors to invest in a collection of industries within a single economic sector, enabling diversified exposure to that sector.
Industry ETFs: In contrast, industry ETFs concentrate on a specific industry within a sector. These ETFs provide a more focused investment in a particular industry, like technology within the larger sector of information and communication. Industry ETFs enable investors to target specific trends or hedge against risks within a particular industry.
In addition to ETFs, other types of ETPs may also offer sector or industry-focused investment opportunities. However, it's important to differentiate between ETFs and other ETPs:
ETFs are investment funds traded on stock exchanges, often designed to track indices, commodities, or baskets of assets. They can be sector or industry-specific, as explained above.
Other ETPs, such as ETNs or ETCs, also provide exposure to different market segments but may have different structures, risks, and regulatory frameworks. For example, ETNs are debt instruments issued by financial institutions, and their performance is tied to a specified market index or strategy, while ETCs focus specifically on commodities.
Leveraged and Inverse
Leveraged and inverse ETPs and ETFs offer a unique investment approach. Leveraged ETPs seek to magnify the performance of an underlying index or asset class by employing financial derivatives. This amplification is achieved through the use of leverage, which can lead to increased potential returns as well as heightened risk. Meanwhile, inverse ETPs are financial instruments that aim to achieve returns that are inversely correlated to the performance of a specific benchmark or index. For example, if the underlying index decreases by 1%, an inverse ETP designed to inversely track that index would aim to increase by 1%, before fees and expenses.Â
These products cater to sophisticated investors seeking higher returns or hedging strategies. However, investing in leveraged and inverse ETPs carries inherent risks, particularly in volatile markets. Thereâs the potential for returns to deviate significantly from the performance of their underlying index or benchmark over time.
Costs and Fees
Like all investment vehicles, both ETPs and ETFs incur costs and fees. These fees, known as expense ratios, vary depending on the type of fund. On average, the expense ratio for ETFs is about 0.16% for index ETFs, which aim to track a specific market index. In comparison, the broader industry average, which includes both ETFs and mutual funds, tends to be higher, around 0.47%. These expense ratios cover the fund's operating expenses, such as administrative costs and portfolio management fees.
Apart from expense ratios, investors may also incur brokerage commissions for trading ETPs and ETFs. Itâs worth noting that investors typically incur lower fees when investing in ETFs, as compared to mutual funds. However, to minimize costs, investors can select index funds with lower expense ratios in comparison to actively managed funds.
Additionally, investors should evaluate the expenses related to purchasing and selling ETFs, and be mindful of both transparent and hidden fees linked to their chosen ETFs.
How to Choose Between ETPs and ETFs
The decision between ETPs and ETFs rests largely upon your investment goals, risk tolerance and preferred exposure. Your investment objectives significantly influence the choice between ETPs and ETFs, as they determine the underlying assets or benchmarks being tracked.
Risk tolerance is another crucial factor. ETFs typically represent lower-risk options due to their diversified nature and lower costs, making them more appealing to investors with a lower risk appetite. On the other hand, certain ETPs, such as leveraged or inverse products, involve higher risk and are generally more suitable for investors willing to assume greater risk levels.
Desired exposure is also a crucial factor in the selection of ETPs or ETFs, as it significantly influences how an investorâs portfolio will fare in various market conditions.
Advantages and Disadvantages of ETPs vs. ETFs
ETPs and ETFs each offer distinct advantages and disadvantages, but it's crucial to differentiate between them accurately. ETFs, being a subset of ETPs, generally provide benefits such as diversification, liquidity, and tax efficiency. They are known for their wide range of investment options and the ease of trading, similar to stocks. However, some types of ETFs may incur additional expenses due to active management or specialized investment strategies.
On the other hand, other types of ETPs, such as ETNs or ETCs, can have different cost structures and risks. While they also offer diversification and can be tax-efficient, their trading costs and expense ratios can vary significantly based on their specific structure and the underlying assets they track. For example, ETNs may have lower operating costs but carry credit risk, whereas ETCs focused on commodities might have unique storage and handling costs.
It's important to note that the potential impact on market stability during periods of volatility can be a consideration for both ETFs and other ETPs, depending on their composition and the market segments they target.
Real-Life Examples of ETPs and ETFs
To further elucidate the concepts above, letâs consider some real-world examples.Â
The SPDRÂź S&P 500Âź ETF Trust (SPY) is acknowledged as the pioneering ETF. It was introduced on Jan 22, 1993, and holds the position of the largest ETF in the market. SPY is structured to replicate the performance of the S&P 500Âź Index, offering investors access to 500 of the most prominent and well-established companies in the U.S. stock market.
Recently, Bitcoin spot ETFs have been approved, offering investors exposure to the performance of Bitcoin, the worldâs largest cryptocurrency. These innovative ETFs highlight the variety of investment options available in the world of ETPs and ETFs.
Potential Risks and Rewards
Similar to all investments, ETPs and ETFs come with both potential risks and rewards. Market risk refers to the possibility of ETPs experiencing detrimental price changes as a result of market volatility, fluctuations and various socioeconomic and political risks. ETPs carry the risks of the assets they invest in, such as commodities and bonds. These risks are inherent to the underlying assets, and can impact the performance of ETPs.
Investors should also be aware that if issuing companies of exchange-traded notes face financial difficulties, such as bankruptcy, they may be unable to fulfill their payment obligations, which can potentially leave ETN holders with significantly devalued net assets or worthless investments.
Nevertheless, the potential rewards can be significant. The returns on ETNs are typically tied to the performance of underlying indices or benchmarks (after deducting any fees), offering the potential for attractive returns.
Summary
Both ETPs and ETFs present effective ways to diversify an investment portfolio, each with its unique structural, regulatory, and trading characteristics. ETFs, a subset of ETPs, are typically favored for their liquidity and a broad array of low-cost options, especially in the case of passive index-tracking ETFs.Â
However, the broader category of ETPs, which includes products like ETNs and ETCs, offers varied structures and can cater to specific investment needs with different cost implications and risk profiles. When selecting between an ETP or ETF, it is crucial to thoroughly understand your investment goals, risk tolerance, and the specific market exposure you desire, ensuring that your choice aligns with your overall investment strategy.
#Bybit #TheCryptoArk