What’s an ETP?

Looking for a low-cost, long-term, hands-off way to invest?

ETPs may be the answer you’ve been searching for.

ETPs, short for exchange-traded products, are securities that are traded on the regular stock exchanges but track another underlying instrument. They are typically not managed, making them a much less expensive option than a traditional mutual fund.

Even large companies like JP Morgan are realizing that ETPs might be a better investment option, as they have transferred over $10 million in assets from mutual funds to a type of ETP called ETFs. The individual speaking on behalf of JP Morgan stated they made this move because of the potential for growth in the ETP space.

Before you start buying ETPs to your heart’s content, take a few minutes to review the pros and cons of ETP investing (as ETP investing, like any other type of investment product, does carry risk). This way you will be well equipped when it comes to making any serious decisions when it comes to ETPs.

Ready to become knowledgeable about all things ETPs? Let’s get to it!

What Exactly is an Exchange Traded Product?

An exchange-traded product, abbreviated as an ETP, is an investment product that tracks another asset on the stock market. The asset which is tracked can vary, from a simple security to an entire index. 

ETPs are typically considered to be passive investments, and many investors add them to their portfolios to diversify. ETPs typically have lower fees than index funds, and their prices will fluctuate throughout the course of the trading day. 

Different Types of ETPs 🗃

There are several different types of ETPs, and the benefits you receive from investing in one will depend on the type you select. The most common ETP that many are familiar with is the Exchange Traded Fund.

Exchange-Traded Funds (ETFs) 📙

An Exchange Traded Fund (ETF) is a security most closely related to the mutual fund, as it is an investment that contains a collection of assets rather than a single product or company. These assets can include stocks or bonds, or a mix of both. 

ETFs are convenient because they are traded on the traditional stock market, and only involve a single purchase to own stocks in multiple companies. This eliminates the burden of going through multiple purchase orders for multiple stocks. ETFs can be a random mix of companies, or an index of companies from a certain sector like technology, energy, or consumer staples. 

The most popular ETF on the market is the S&P 500 which tracks the performance of the top 500 large-cap companies in the U.S. Investors love ETFs because they have low fees, and are the type of investment you don’t have to check in on every day. Many investment professionals expect ETFs to surpass traditional fund investing within the next couple of years. 

Exchange-Traded Notes (ETNs) 📘

ETNs are very similar to ETFs in that they are investment products that also track an index and can be found for sale on most exchanges. But unlike ETFs, ETNs are based on unsecured debt.

The returns an investor receives from investing in an ETN is similar to a bond, as it is based on a maturity date, and the original amount invested, plus interest. ETNs do not pay interest in the way other securities can. 

It’s important to note that when investing in ETNs, you don’t actually own any of the underlying assets. Therefore, ETNs are riskier than some of the other ETPs available on the market. The risk of investing in ETNs can be evaluated by looking at the creditworthiness of the issuer. In this sense, the associated risk is ultimately calculated on a case-by-case basis.

Exchange-Traded Commodities (ETCs) 📗

ETCs or exchange-traded commodities are similar to ETNs as they too are debt instruments that do not return interest payments to the investor. While they still track a collection of commodities, ETCs are specifically designed to allow an investor to have exposure to international commodities. 

ETCs can include various types of commodities such as livestock, precious metals, or even energy. But unlike ETFs, when you invest in ETCs, the index invested in will only contain a certain commodity. For example, you would invest in an ETC that is a collection of precious metals only.

The benefit of ETCs is largely related to investor access to certain markets. For investors that lack access to commodities through either spot or derivatives markets, they gain exposure to commodities through ETCs.

While ETCs aren’t considered as expensive as other types of investments, they do tend to have more fees associated with them than an ETF. This is because ETCs are based on futures contracts rather than a simple investment in a company, which requires more oversight–thus costing the investor a higher fund management fee. 

How Do ETPs Benefit Investors? 🤔

Feeling a little nervous about investing in ETPs? Let’s take a look at some of the advantages. ETPs have many benefits that can sometimes outweigh the associated risks when it comes to adding them to your portfolio. 

ETPs first of all, have a low barrier to entry. This makes them a very easy product to start with for those brand new to the investment world and without a lot of initial capital. Not to mention they can help an early investor get involved with multiple products or companies with just one buy order rather than several. 

Additionally, prices are updated throughout the day, so you will always know the value of your investment. ETPs are also quite liquid, so you shouldn’t have a problem selling them if you change your mind and want to invest in something else. 

Because ETPs are currently in a stage of growth around the world, investors will find that they can use them to invest in almost any product. For example, someone wanting to invest in companies like Tesla and Apple, but without the initial capital needed to buy a single share of each, will find a Technology ETF that will have them invested in the same companies without needing to hand over a large amount of cash. 

How Are ETPs Regulated? 🛡

Like any other product available for purchase through a broker, ETPs are heavily regulated. But the type of regulation will depend on the product your ETP tracks.

ETFs are regulated by the SEC under regulation 6c-11 and the Investment Company Act of 1933 which specify that ETFs must be transparent with their investors regarding their holdings at all times. An ETF is also required to provide investors with certain historical performance figures achieved by the fund as well as maintain certain record-keeping standards. 

All ETP products, whether they are ETFs, ETCs, or ETNs are required to be registered with the SEC, to trade publicly. But there is one loophole: to be permitted to list publicly, an ETP does not need to be a financial company.

This brings up some concerns, especially if a Bitcoin ETF is permitted, as regulators fear this investment product will confuse investors who will not realize the possible volatility of such a product. Further, there is no regulation specifying the company behind it must be a financial company. 

Exchange Traded Products: Evaluating Factors 📝

As you compare investing in ETPs to other investment products there are a few key areas you should take into consideration. Let’s jump into three important aspects that all investors need to evaluate. 

The Structure of ETPs Explained 👨‍🏫

The way in which an ETP is structured will affect the way it runs—as well as the associated fees and the risks involved with its purchase. ETPs typically have one of two structures: one in which the ETP purchases the underlying assets it is tracking, and another where a swap agreement is struck with a third party, but no assets are actually owned. This latter version is known as a synthetic agreement.

These synthetic agreements, as you can imagine, carry far more risk than their traditional counterparts. The reasoning is straightforward—none of the underlying assets are actually owned by the investors. Therefore, these are heavily regulated by the SEC and not widely available to all American investors. 

Synthetic ETPs will be listed on the exchange with an ‘X’ in front of their name or ticker symbol. This is to warn investors that they should fully understand what they are investing in before they put their money in that particular asset. 

How Liquid Are ETPs? 📊

The liquidity of an ETP can be determined by evaluating the volume in which the ETP is traded as well as how the assets within the ETP are priced. In general, ETPs which have their prices based on the assets or index they track are often more liquid than those which are priced-based on the laws of supply and demand. 

For example, a popular ETF such as the S&P 500 is much more liquid than a lesser-known ETF for a smaller sector as people are typically always looking to purchase the S&P 500. On the other hand, a Cryptocurrency ETF might be more illiquid, as the prices of this type of asset are much more reliant on supply and demand, meaning if the price drops, it’s because demand has dropped and those wishing to sell will encounter difficulty. 

It also takes a special type of investor to get involved in the cryptocurrency type of ETFs since this is still a widely unregulated and volatile area of finance. So even if you are willing to take a chance on a cryptocurrency ETP, you need to evaluate the future liquidity to decide if it is an asset you would be willing to hold long term if the cryptocurrency market were to enter a downturn. 

Know the Risk in ETPs ⚠

The question of the hour before you buy an ETP is, of course, how much risk you will be exposing yourself to. The risks of ETPs are usually comprised of a mix of market fluctuations, taxes, and currency considerations (in the case of certain ETCs).

Keep in mind that choosing an ETP that physically invests in the product exposes you to different risks than the synthetic ETPs. Investing in physical products exposes you to sampling risks while synthetic ETPs expose you to the risks that come along with working with a third party. 

Additionally, the liquidity of your product will also contribute to your risk. More liquid assets like the S&P 500 will be easy to sell if you need to close your position at any point. Other assets which aren’t as liquid will increase the risk you are exposed to when you invest in them. In summary, liquidity can pose an issue, with the ultimate result being potentially increased risk.

ETPs vs. Mutual Funds ⚔

Although ETPs may sound like a great investment, it can be difficult to let go of the more common mutual fund due to its popularity. So before you make any decisions you may regret, let’s make a quick comparison of these two products.

A Closer Look at Fees 🔍

Mutual funds, like ETPs, are made up of a mix of securities. But unlike ETPs, these funds are actively monitored and changed regularly by a professional in the industry. These professionals or money managers are paid a fee for their work managing the fund which can eat up a notable portion of your returns.

ETPs, on the other hand, are not actively managed, which means the fees are a lot lower. Most ETPs, rather than charging annual fees, collect their money from investors when said investor decides to buy or sell their product. Be cautious, however, as not all ETPs are alike, and some will carry additional fees that may be higher than those assessed by a mutual fund. 

You can see the fees of an ETP or mutual fund by taking a look at the expense ratio. Generally, the fees for an ETP are under 1%, while the fees for mutual funds can be as low as 1% up to and including 5%. 

Diving Further Into Pricing 💰

The way in which mutual funds and ETPs are priced varies widely from platform to platform. Many mutual funds require an initial buy-in amount, while ETPs only require that you be able to purchase one unit of the ETP to begin investing. This makes ETPs more accessible for those new to trading. 

For instance, many of the larger brokerages which offer mutual funds, such as Vanguard, require an upfront investment of at least $3,000 worth of capital. Meanwhile, a single purchase of the S&P 500 ETF will cost an investor just a couple of hundred dollars. 

Of course, not all platforms are alike, which is why it is worthwhile to do a little research before you pick the platform you plan to use for the long-term. Almost all platforms offer access to some sort of ETP or mutual fund. 

Flexibility Compared ⏳

Mutual funds are only priced at the end of the day, and there are limitations when an investor is allowed to buy and sell mutual funds. ETPs, for the most part, have a live price that fluctuates throughout the course of the day allowing trades at any given time. 

Not to mention that you typically are not allowed to cash out mutual funds whenever you want. Rather, you must hold the funds for a certain period of time which will be specified when you buy into the fund. 

Most mutual funds require you to hold them for at least a year, making it difficult to cash out your investment if you were to need the money. When owning an ETP, you can sell at any point you desire, even the same day you buy it.

Which Has More Liquidity? 🌊

It is always easier to get off a boat that is still making its way across the ocean rather than one which is rapidly sinking. In this fashion, ETPs are becoming more and more popular in the marketplace, meaning they offer much more liquidity and are easier to buy and sell on a daily basis. 

Mutual funds are much more illiquid, and the company behind the fund will typically dictate when you can buy and sell them, therefore people have become less and less interested in mutual funds as the years have gone by. The popularity of ETPs is growing, and new ones are being introduced all the time, because, as it turns out, people like being able to sell their investment whenever they want.

Thus, when you wish to close your position, you will likely have more investors looking to purchase your ETP shares than your mutual fund shares. So if you are looking for a liquid investment, ETPs are preferred to mutual fund shares. 

How Do ETPs and Mutual Funds Differ in Risk? 🧐

There are ETPs on the market that are leveraged, and those which are based on debt instruments. These two factors make some ETPs much riskier than their mutual fund counterparts, especially when it comes to products like ETNs and ETCs. 

This doesn’t mean all ETPs are risky, however, as some ETFs, like the S&P 500 have shown nothing but overall consistent growth for decades. You just need to take extra care to evaluate the risk of an ETP before you consider investing.

And remember, ETPs are typically not actively managed, therefore if a certain stock in the ETP declines suddenly it’s unlikely the fund will immediately be rebalanced to eliminate that asset, and it could cause the price of the ETP to drop. A mutual fund manager is there to watch a mutual fund and ensure situations like this don’t occur. 

Are Brokerage Accounts Needed for Both ETPs and Mutual Funds? 👨‍💻

Generally, most ETPs require a brokerage account to trade, while mutual funds do not have the same requirement. This also means that trading ETPs could result in brokerage fees being assessed when trading mutual funds. 

This is why many beginning investors prefer to start with ETFs when they are just beginning their portfolio, because they may purchase them on a particular platform, then later decide they would like to switch to a different one. If a beginning investor starts out by purchasing a mutual fund, he may be locked on the platform for months or even years. 

As you can see, there are many pros and cons to investing in both types of assets. Take a look at this chart to better get an idea of the pros and cons of ETPs versus mutual funds. 

Growth and Example of ETPs 📚

To date, the largest ETP is the S&P 500 ETF. This is a physical ETF, meaning the ETF owns physical shares of every company listed in the S&P 500 index. This index contains some of the highest-performing companies in the world like Amazon, American Express, Ford Motors, Home Depot, and IBM. 

Say an investor decided to put $1,000 in this particular ETF on February 10, 2020. At the time, one share of the S&P 500 was $321.73, so he would have purchased just over 3 shares. 

Then, if he held onto his shares during the bear market which followed, and sold almost one year later, on February 1, 2021, he would have sold the shares for $387.71 for a total of over $1,163.13 or about a 16% rate of return. 

Now you could say that this was a one-off thing and that the above investor simply got lucky investing right before the COVID19 pandemic and holding onto the investment while many others decided to sell theirs off. But the reality is, the S&P 500 has been on a growth trajectory since its invention in 1926. And disregarding a few market corrections it seems to be continuing on its same path. 

Which Type of Investor is Best Suited to ETPs? 🌟

Still not sure if ETPs are the right choice for you? ETPs aren’t for everyone, so it’s time to break down exactly who ETPs are good for. 

Newer Investors 🤓

ETPs are great for a beginning investor looking for an investment that they can buy and leave in their portfolio. Because of their low cost, a new investor will like being able to get involved in purchasing stock in companies they wouldn’t have access to otherwise. 

ETPs don’t require a long-term commitment to a brokerage either, and because they are typically liquid, a newer investor will find it simple to sell the ETPs purchased on one brokerage platform and change to another if they so choose. This is much less stress as a beginning investor as you can approach an ETP investment knowing it isn’t permanent. 

For example, a beginning investor can purchase the Vanguard S&P 500 ETF on Vanguard’s platform without needing a high-level brokerage account. Then later, if they decide they would rather try Charles Schwab’s S&P 500 ETF, it is simple to sell the earlier shares and open a new account to buy the latter on the other platform. This can all be done without high account fees or needing to wait a certain period of time. 

Long-Term Investors 🗓

Regardless of the price, if you are looking for some exciting day trading action, it is unlikely you will enjoy investing in ETPs as they are typically a better long-term investment. But for those looking for an asset they find, research, then leave to grow, ETPs can be a great option.

Now, this doesn’t mean there won’t be any research involved. However, rather than researching on a daily basis, long-term investors will be able to do the initial research required for an asset purchase, make the purchase and leave it be. 

Investors Who Prioritize Risk Management 📈

Although any sort of investment is risky, ETPs are sometimes considered to be less risky than other investment strategies. Some ETPs, like ETFs, carry less risk than investing in a single company, because of the fact that they follow an index. This way, if a single company in the index goes under, the investor may experience a dip in the price of the ETF, but the entire ETF won’t decline to zero, as the company’s stock would. 

In this same manner, if you purchase an ETF belonging to a certain sector, such as a technology ETF, and a major incident occurs, such as the dotcom crash of the early 2000s, you could still risk taking huge losses when investing in an ETF.

But remember, with higher risk, comes higher reward. Therefore the lower level of risk involved in investing in ETPs may not have a high enough return for some investors. Those who are fine with a modest reward attached to a modest amount of risk should consider investing in ETPs. 

Investors Who Don’t Mind Leaving Others in Charge ⛓

One more thing to mention, and that is the fact that when you invest in an ETP, you don’t get to pick the makeup of the ETP yourself. This means when you buy an ETP share, you are investing in every company in the ETP whether you like it or not. 

Obviously, you can pick a more specific ETP that can help you avoid investing in some companies you don’t like. But if you think you want to pick every single company which is included in your ETP, they are not for you. 

The Good and the Bad with ETPs ⚖

We’ve covered how ETPs work in extensive detail. Let’s briefly summarize their benefits and drawbacks:

Conclusion 🏁

All in all, if you are looking for some low-cost long-term investing, which can be particularly beneficial for beginners, then you may have found your match with ETPs. Be careful which ETP product you choose to invest in however, as they all carry different levels of risk. 

Thanks to their popularity, even if you invest in ETPs and ultimately decide they aren’t for you, their liquidity will allow you to change your investment in the future. Whether you decide to add ETPs to your portfolio or not is ultimately up to you, but be sure any investment you choose aligns with your desired risk levels and long-term investing goals. 

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