THE UNIVERSE OF LISTED PRODUCTS: ETPs VS. ETFs
In the dynamic investment world, Exchange Traded Products (ETPs) have gained significant popularity, offering investors diversified access to a wide range of assets. Within this category, Exchange Traded Funds (ETFs) are perhaps the best known. However, it is crucial to understand that ETFs are a type of ETP, and not all ETPs are ETFs. This article will explore the fundamental differences between the two, their valuation, performance, the implications of MiCA regulation and their distinctive properties.
WHAT ARE ETPs? AN OVERVIEW
Exchange-traded products (ETPs) are a broad term that encompasses a variety of financial securities that are listed on stock exchanges, similar to equities. Their price fluctuates throughout the day depending on supply and demand. ETPs are designed to track the performance of an index, a commodity, a currency or a specific investment strategy.
Under the umbrella of ETPs there are different legal structures, the most common being:
- ETFs (Exchange Traded Funds): Investment funds that replicate the performance of an index, sector, commodity or strategy. They allow the creation and redemption of units, which helps to keep their price in line with the NAV of the underlying.
- ETNs (Exchange Traded Notes): Unsecured debt securities issued by a financial institution. They promise to pay the investor a return based on an index or underlying asset. The investor assumes the credit risk of the issuing institution.
- ETCs (Exchange Traded Commodities): Products that track the price of one or more commodities (gold, oil, etc.). They are usually backed physically by the commodity or through futures contracts.
ETFs: THE PREDOMINANT OPTION
Exchange-traded funds (ETFs) are collective investment vehicles that operate in a similar way to traditional mutual funds, but with the characteristic that their units are traded on the stock exchange like shares. Their main objective is to replicate the performance of a benchmark index (e.g. IBEX 35, S&P 500) or a specific basket of assets.
Key characteristics of ETFs
- Diversification: They offer access to a wide range of assets with a single investment.
- Liquidity: They can be easily bought and sold in the secondary market during trading hours.
- Transparency: The composition of their portfolios is usually public and regularly updated.
- Generally low costs: They tend to have lower management fees than traditional mutual funds.
- Flexibility: They allow the implementation of various investment strategies.
KEY DIFFERENCES BETWEEN ETPs AND ETFs
The main difference lies in the legal structure and the type of underlying asset. While ETFs are always investment funds, ETPs encompass other structures such as ETNs (debt) and ETCs (commodities).
| Characteristics | ETFs (Exchange Traded Funds) | ETNs (Exchange Traded Notes) | ETCs (Exchange Traded Commodities) |
|---|---|---|---|
| Legal Structure | Investment fund | Unsecured debt security | Various structures (funds, debt, etc.) |
| Credit Risk | Generally low | Present (issuer risk) | Generally low (if backed) |
| Underlying Asset | Indices, baskets of stocks, bonds etc. | Indices, commodities, currencies, etc. | Commodities |
| Guarantee | The assets of the fund | None (issuer’s promise to pay) | Physical backing may be available |
VALUATION AND PERFORMANCE: A COMPLEX PERSPECTIVE
VALUATION: ETFs and other ETPs are priced in real time according to supply and demand in the market. However, ETFs tend to maintain their price close to their net asset value (NAV) due to the creation and redemption mechanism. ETNs may deviate more from their notional value due to credit risk and market conditions. ETCs, especially those physically backed, tend to have a valuation more directly linked to the price of the underlying commodity.
PERFORMANCE: The performance of an ETP or ETF is directly linked to the performance of the asset or index it replicates. It is not possible to state categorically which one ‘outperforms’ as this depends entirely on the underlying market and the investment strategy.
- Equity ETFs: Their performance will depend on the performance of the stocks that make up the index they replicate.
- Fixed income ETFs: Their performance will be influenced by interest rates and the credit quality of the underlying bonds.
- ETNs: Their performance will track the underlying index or asset, but is subject to the credit risk of the issuer.
- ETCs: Their performance will reflect the price performance of the underlying commodity and may be affected by storage and management costs (in the case of physical replication) or rollover costs (in the case of futures replication).
It is crucial to analyse the benchmark and replication strategy of each product to understand its performance potential and associated risks.
THE IMPACT OF MICA ON ETPs AND ETFs
The EU’s Markets in Cryptoassets Regulation (MiCA) aims to establish a harmonised regulatory framework for cryptoassets. Its impact on ETPs and ETFs will depend on whether these products include cryptoassets as underlying assets.
- ETPs/ETFs that track cryptoassets: MiCA will establish specific requirements regarding issuer authorisation, transparency, investor protection and supervision. This could lead to greater clarity and legal certainty for these products, but could also entail additional compliance costs for issuers.
- ETPs/ETFs that do not include cryptoassets: In principle, MiCA should not have a direct impact on these products, as their regulatory framework is already established by other directives (such as UCITS or AIFMD).
However, it is possible that the implementation of MiCA will generate greater interest in and general understanding of digital assets, which could indirectly influence the market for other ETPs and ETFs.
DISTINCTIVE PROPERTIES
Beyond their legal structure and underlying assets, the different types of ETPs have distinctive properties:
- ETFs: They stand out for their versatility, liquidity and transparency. They are fundamental tools for the construction of diversified portfolios and the implementation of tactical or long-term strategies.
- ETNs: They offer access to complex markets or strategies that may be difficult to replicate directly. However, issuer credit risk is a crucial factor to consider.
- ETCs: Allow investors to take positions in the commodities market in a more accessible way than through physical purchase or direct futures contracts. The replication structure (physical or synthetic) is an important property to analyse.
CONCLUSION
The choice between an ETP and an ETF will depend on the investment objectives, risk tolerance and knowledge of the investor. ETFs, as a well-established and regulated category, offer a wide range of options with transparency and liquidity. Other ETPs, such as ETNs and ETCs, may provide access to specific markets or complex strategies, but with additional risk considerations.
Understanding the fundamental differences between these products, their valuation, performance potential, the impact of regulations such as MiCA and their distinctive properties is essential to making informed investment decisions and constructing a portfolio that aligns with individual needs.
Disclaimer: The information set forth herein should not be taken as financial advice or investment recommendation. All investments and trading involve risk and it is the responsibility of each individual to do his or her due diligence before making a decision.
