What Is an Exchange-Traded Product (ETP)?
Exchange-traded products (ETPs) are instruments that track underlying securities, an index, or other financial products. ETPs trade on exchanges similar to stocks, meaning shares can be purchased, and prices can fluctuate throughout a trading day. ETP share prices are derived from the underlying investments that they track.
Key Takeaways
- Exchange-traded products (ETP) are instruments that track underlying security, index, or financial products.
- ETPs trade on exchanges similar to stocks.
- The price of ETPs fluctuates from day to day and intraday.
- The share price of ETPs comes from the underlying investments that they track.
Types of Exchange-Traded Products (ETPs)
Exchange-traded products can be benchmarked to myriad investments, including commodities, currencies, stocks, and bonds. ETPs can contain a few or hundreds of underlying investments. Here are the types of ETPs trading on the market.
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 it can follow an industry, sector, commodity, or even a currency. An exchange-traded fund's price can rise and fall just like other investments. Contrasted with mutual funds that can only be traded after hours, these products trade throughout the day.
The popularity surrounding ETFs stems from their low fees since many are passively managed. For example, a passively managed ETF might track the , one of the most popular large-cap stock indexes. An ETF that mirrors the S&P 500 will generally hold all stocks listed on the index, but some funds hold more or less than the index lists—an example is Vanguard's S&P 500 ETF, which held 505 stocks on Feb. 1,, 2024, while the S&P 500 listed 503.
In January 2024, the Securities and Exchange Commission approved the first Bitcoin Spot ETFs, allowing fund managers to hold Bitcoin and offer exchange-traded shares to investors on official exchanges.
In an actively managed fund (which an ETF can also be), the fund manager is responsible for maintaining fund performance by replacing non-performers with better performers, which can lead to higher fees—the managers need to be paid for their time, and there might be some trading fees to pass on. Some ETFs share a combination of both passive and active attributes.
For example, actively managed exchange-traded funds are a hybrid investment vehicle that merges actively managed mutual funds with the trading flexibility associated with ETFs.
Exchange-Traded Notes (ETNs)
Exchange-traded notes (ETNs), like ETFs, generally track an underlying index and trade on major exchanges; however, they track unsecured debt securities and are issued as bonds. ETNs are issued as bonds, which pay the return of their original invested amount—the principal—at maturity and any returns generated. ETNs do not pay periodic interest payments (called coupon payments). As a result, the likelihood that investors will be paid back the principal and the returns from the underlying index depends on the issuer's creditworthiness.
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 Commodities (ETCs)
Exchange-traded commodities (ETCs) are financial instruments designed to offer investors exposure to commodity prices. These instruments can be structured as either ETFs or ETNs. ETCs are traded on stock exchanges, allowing investors to easily access and trade them just like they were individual stocks.
The underlying assets of ETCs typically include a range of commodities such as precious metals, agricultural products, energy resources, or a combination thereof. ETCs let investors buy and sell commodities without holding or owning any of the underlying commodities. This means investors can capitalize on specific commodities, commodity indices, or commodity futures contracts without ever having to store or hold a tangible commodity.
Exchange-Traded Products vs. Mutual Funds
Mutual funds are typically priced at the end of the trading day when orders are actually filled. ETP shares trade like stocks with price movements throughout the day. For example, an investor can place a buy or sell order for an ETF share at a specific price with a broker or buy the ETF in the morning and sell it by the end of the day. Mutual funds can be purchased and sold during the day but are not priced until the market closes. ETPs also often carry lower expense ratios than their mutual fund counterparts.
Additionally, differences in the bid and ask—the 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.
Pros
ETPs offer investors access to many securities and indices.
ETPs are usually a low-cost alternative to mutual funds and actively-managed funds.
Many ETPs, particularly ETFs, are gaining inpopularity, providing additional liquidity.
Cons
ETPs have the risk of market losses since their prices fluctuate.
ETPs are popular products but have varying trading volumes, which can affect liquidity.
Growth of Exchange-Traded Products
Since the debut of the first ETF in 1993, ETPs have grown significantly in size and popularity. At the end of 2023, global ETFs had almost $11 trillion in total assets under management (AUM). The low-cost structure of ETPs has contributed to their popularity, which has attracted assets and capital away from actively managed funds.
Real-World Example of an ETP
The largest ETF in the marketplace is the SPDR S&P 500 ETF (SPY), with assets of more than $480 billion as of January 2024. The ETF owns shares of all 500+ stocks listed on the S&P. Here are a few of the top companies held by SPY:
- Apple Inc.
- Microsoft Corp.
- Amazon.com Inc.
- NVIDIA Corp.
- Alphabet Inc.
- Meta Platforms Inc. (formerly Facebook)
How Do Exchange-Traded Products (ETPs) Differ From Traditional Investment Options?
ETPs differ from traditional investment options, such as mutual funds, in their structure and tradability. ETP shares are traded on stock exchanges throughout the trading day at market prices, providing intraday liquidity and flexibility. Traditional options often involve buying or selling at the end of the trading day at the NAV price. Additionally, ETPs can track various indices, commodities, or currencies, allowing for more targeted investment strategies.
Are ETPs Traded on Stock Exchanges?
Yes, ETPs are traded on stock exchanges. This means that investors can buy and sell ETP shares throughout the trading day at market prices. The stock exchange environment enhances liquidity and provides real-time pricing information for ETPs.
How Do Leveraged and Inverse ETPs Work?
Leveraged ETPs seek to magnify the returns of an underlying index or asset class using financial derivatives and debt. Inverse ETPs, on the other hand, aim to provide the opposite (inverse) performance of the underlying index. These ETPs are designed for sophisticated investors seeking to capitalize on short-term market movements, often contrasting how the ETF is naturally moving.
What Are the Risks Associated With Investing in ETPs?
Investing in ETPs carries various risks, including market risk, liquidity risk, tracking error, and specific risks associated with the underlying assets. Market conditions, geopolitical events, and interest rate changes can impact ETPs' performance. In many ways, an ETP can be considered similar to a stock. Consider all the ways a business can face risk—an ETP is susceptible to similar risks.
The Bottom Line
Exchange-traded products are financial instruments traded on stock exchanges that provide investors with exposure to diverse asset classes such as stocks, bonds, commodities, and currencies. ETPs can be ETFs, ETNs, ETCs, or other vehicles representing structured investment products.
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