Exchange traded products (ETPs) are types of securities that track underlying securities, an index, or other financial instruments. ETPs tra...
Types of Exchange Traded Products
Exchange traded products can be benchmarked to myriad investments including commodities, currencies, stocks, and bonds. Since prices of ETPs can fluctuate, investors have the potential to earn gains but also have the risk of market losses. ETPs can contain a few or hundreds of underlying investments.
Exchange Traded Funds (ETFs)
Similar to a mutual fund, an exchange traded fund contains a basket of investments that can include stocks and bonds. An ETF usually tracks an underlying index such as the S&P 500 but can follow an industry, sector, commodities, or even currency. An exchange-traded fund's price can rise and fall just like other investments. These products trade throughout the day just as a stock would trade.
The popularity surrounding ETFs stems from their low fees since they are passively managed. For example, a passively-managed ETF might track the S&P 500. Here, the ETF owns all 500 stocks contained in the index. Conversely, an actively-managed fund involves an investment manager buying and selling securities, which can lead to higher fees. Some ETFs share a combination of both passive and active attributes.
Exchange Traded Notes (ETNs)
Exchange traded notes (ETNs), like ETFs, also track an underlying index of securities and trade on major exchanges. However, ETNs are baskets of unsecured debt securities. The ETN pays investors the return received from the index they track at the maturity date, less any fees or commissions.
ETNs are similar to bonds in that investors receive the return of their original invested amount—the principal—at maturity. However, the ETN does not pay periodic interest payments. Also, investors who buy ETNs do not own any of the securities in the index they track. As a result, the likelihood that investors will be paid back the principal and the returns from the underlying index is dependent on the creditworthiness of the issuer.
Different tax treatments apply to the various types of ETPs. Investors should speak with a tax professional for any potential tax ramifications from investing in ETPs.
Exchange Traded Products vs Mutual Funds
Exchange traded products were developed to create investments that had more flexibility than mutual funds. Mutual funds are funds that are comprised of a basket of securities that are funded by a collection of investors and managed by professional money managers.
Mutual funds are typically priced just once at the end of the trading day. ETPs trade like stocks and can be bought and sold throughout the day and have prices that move throughout the day. For example, an investor can place an order with ETFs to buy or sell at a specific price with a broker. Investors can buy the ETF in the morning and sell it by the end of the day whereas mutual funds do not have that flexibility. ETPs often carry lower expense ratios than their mutual fund counterparts.
ETPs also require a brokerage account to trade, so buying and selling ETP shares could result in a brokerage commission if it isn't one of the ETFs that the brokerage allows to be traded freely. Most highly liquid ETPs can be traded without a commission charge in all the major discount brokers. Additionally, differences in the bid and ask—buy and sell—price could add to the cost of trading ETPs. Some no-load or no-fee mutual funds, on the other hand, can be bought and sold without any trading commission, and they do not require a brokerage account.
