Investors are often looking for ways to diversify their portfolios, and one way to do that is with exchange-traded products, or ETPs. These are securities available on stock markets that work like stocks, since both have fluctuating prices and are publicly traded. ETPs differ from stocks, however, because they are used to track a specific financial instrument, like a currency, interest rate, commodity, or share-price index.
Exchange-traded products let you acquire exposure to an index or asset class. They are generally considered safe and cost-effective ways to diversify an investment portfolio. These products are typically classified as passive investments. This is because they tend to have lower fees relative to index funds and active mutual funds.
It pays to learn about the similarities and differences between ETPs and stocks if you’re putting together an investment portfolio. This guide will give you a solid understanding of ETPs and their pros and cons in hopes of helping you find a new path toward earning attractive returns.
Types of Exchange-Traded Products
Some exchange-traded products track benchmark indexes, while others monitor common markets like the FTSE 100. Some monitor specialized benchmark indexes like sector-specific shares that pay a high dividend. They fall into three categories, regardless of which you explore:
1. Exchange-Traded Funds (ETFs)
An ETF is commonly used to track an index fund like the S&P 500. It can also be used to monitor a market, currency, industry, or commodity. The prices of ETFs rise and fall, like stocks. These funds are traded in the same way investors buy and sell stocks throughout the day.
2. Exchange-Traded Notes (ETNs)
ETFs and ETNs are similar in that both can be used to track an underlying index of securities and trade on major exchanges. They differ in that ETNs function as collections of unsecured debt securities, however. Those who invest in an ETN get paid the return received from the index they track at a set maturity date. These investors aren’t charged any fees or commissions, either.
3. Exchange-Traded Commodities (ETCs)
You can purchase ETCs that provide access to one debt instrument or a basket of them. These commodities do not come with interest payments and often provide investors with significant exposure to currencies.
It’s easy to get confused about different ETPs and how they work. When you partner with an independent financial advisor, though, you can get expert insights into these funds and other investment vehicles. Your advisors can even outline key reasons to use different investment vehicles.
How ETPs Compare to Other Investment Vehicles
Exchange-traded products are frequently compared to stocks, but they share similarities to other investment vehicles as well. Here are a few things to keep in mind:
- An ETP can operate like an investment trust, which a publicly listed company can use to sell a fixed number of shares to investors.
- The trust is listed on a stock exchange, and money from it is pooled to make investments.
- A fund manager controls the trust, though, unlike an ETP.
- ETPs and open-ended investment companies (OEIC) are similar.
- An OEIC issues shares like an investment trust and relies on investors’ money to drive its growth, but is not listed or traded on a stock exchange.
There is also a unit trust option for those who are considering ETPs or other investment opportunities. A unit trust consists of a collective investment vehicle in which money is pooled to make investments. It operates similarly to an OEIC but is not considered a company, and it issues units instead of shares.
ETPs are distinct in many ways but have similarities to other investment vehicles. Those unsure about which ETPs are best for them should consider seeking expert guidance.
Reasons to Choose Exchange-Traded Products as Investment Vehicles
Anyone on the lookout for a cost-effective and simple-to-use-investment vehicle might look at an exchange-traded product as an option. ETPs have a low barrier to entry and greater flexibility over other investment vehicles. These products can represent excellent options for first-time investors because they can provide access to an alternate asset class or a whole index with a single transaction.
You can easily buy or sell these products in the same way you would stocks. Investors can acquire and exchange these products while the stock exchange is open, and prices are updated throughout the day. ETPs can also provide additional liquidity in comparison to other investment options. Keep in mind, however, that the products can have inconsistent trading volumes, which can affect their liquidity.
3 Factors to Consider as You Evaluate ETPs
There’s a lot to consider as you assess exchange-traded products and how they stack up against other investment vehicles. Here are three factors that can help you evaluate these products:
The replication structure of exchange-traded products affects the risks, costs, and accuracy of the underlying asset it’s tracking. ETPs feature a physical or synthetic structure for replication. Physical options involve purchasing the underlying assets they track, while synthetic ones involve using a swap agreement in which the issuer buys underlying assets via a counterparty.
There are cost, tax, currency, and other dangers to consider, along with the risk of market changes that affect the prices of ETPs. Those who choose physical products are also subject to securities lending and sampling risks. Those who select synthetic products face risks by working with counterparties.
The liquidity of ETPs is often predicated on the volumes traded, and the products are priced based on the underlying asset rather than supply and demand. Understanding how the products are created and redeemed, then, can help you assess the pricing behind them.
The factors above are only a few you need to consider relative to these products. Meeting with an independent investment advisor can give you insights into many investment topics. You can also receive expert help as you seek out ways to develop and optimize your investment portfolio.
Contact an Expert With Questions About Exchange-Traded Products
It’s understandable if you clicked on this post wondering, “What is an ETP,” but you still have questions. Bogart Wealth is committed to our clients’ financial well-being, and our team is well equipped to give you answers. We offer independent investment planning services to help you weigh the pros and cons of exchange-traded products and other options.
Contact our team today to learn more about how we can help you achieve your investing goals.