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What Is An Exchange Traded Product (ETP)?
An Exchange Traded Product (ETP) is a type of financial security traded on an exchange, similar to a stock. They track a specific underlying asset's performance, such as a commodity, currency, bond, or stock market index.
It offers investors a convenient and cost-effective way to exposure to a diverse range of assets and markets, with the added benefit of liquidity and transparency from trading on an exchange. However, the risks of it include tracking errors, counterparty risk in the case of ETNs, and the potential for liquidity issues in the case of less popular or illiquid ETPs.
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- Exchange Traded Products are a type of financial security that markets on an exchange and track the performance of an underlying asset or index.
- It can take different forms, such as Exchange-Traded Funds, Exchange-Traded Notes, or Exchange-Traded Commodities.
- It offers investors a convenient and cost-effective way to gain exposure to diverse assets and markets. In addition, they provide transparency and liquidity as they market throughout the day on an exchange, allowing investors to quickly and easily adjust their portfolios in response to market movements.
- They have significantly impacted the financial industry, providing a new way for asset managers and investors to access global markets and providing competition to traditional mutual funds.
Exchange Traded Product (ETP) Explained
Exchange Traded Product is a type of financial security that peddle on an exchange that tracks the performance of a specific underlying asset or index, such as a commodity, currency, bond, or stock market index. It can take different forms, such as exchange-traded funds, exchange-traded notes, or exchange-traded contracts (ETCs), but they all share the common feature of being traded on an exchange.
The origin of it lies in the creation of the first ETF in 1993 by State Street Global Advisors. Since then, the popularity of ETFs and other ETPs has increased, with assets under management in exchange-traded funds (ETFs) alone surpassing $6 trillion globally in 2021.
Its significance lies in its ability to offer investors a convenient and cost-effective way to gain exposure to diverse assets and markets. With these, investors can easily invest in a basket of assets that would otherwise be difficult or expensive to access.
These have also significantly impacted the financial industry, providing a new way for asset managers and investors to access global markets and providing competition to traditional mutual funds. In addition, exchange Traded Products have also led to new investment strategies, such as smart beta and factor-based investing, which seek to capture specific investment factors or market anomalies.
Types
There are three main types of exchange traded products:
- Exchange-Traded Funds: These are the most common type of exchange traded products. ETFs are investment funds that hold a diversified portfolio of underlying assets, such as stocks, bonds, or commodities. The value of an ETF is based on the net asset value (NAV) of the underlying assets. ETFs trade on an exchange like stocks; supply and demand determine their prices. ETFs invest in various asset classes, like domestic and international equities, fixed-income securities, and commodities.
- Exchange-Traded Notes: ETNs are debt instruments of financial institutions that track the performance of an underlying index or asset. Unlike ETFs, ETNs do not hold the underlying assets but instead provide investors with a return based on the performance of the underlying investment. The return on an ETN is based on the issuer's creditworthiness, and as such, there is a risk of default by the issuer.
- Exchange-Traded Commodities: ETCs track the performance of a specific commodity, such as gold, silver, or oil. ETCs can hold the physical commodity or use derivatives to provide exposure to the commodity's price movements. ETFs trade on an exchange like ETFs, and their prices are based on the supply and demand for the underlying item.
Examples
Let us understand it through the following examples.
Example #1
Suppose a financial institution created an ETF that tracks the technology sector's performance. The ETF has a diversified portfolio of stocks in companies such as Apple, Microsoft, Amazon, and Google. The ETFs are on a stock exchange, and investors can buy and sell shares of the ETF throughout the trading day.
The value of the ETF is based on the net asset value (NAV) of the underlying stocks, so if the stocks in the portfolio go up in value, the ETF will also increase in value. Conversely, if the stocks in the portfolio decrease in value, the ETF will decrease.
Investors who want exposure to the technology sector can buy shares of the ETF instead of purchasing individual stocks in each company. This provides diversification and reduces the risk of exposure to any one company. Additionally, since the ETF is on an exchange, it provides liquidity and transparency, and investors can quickly and easily adjust their holdings in response to market movements.
Example #2
In October 2021, the United States Securities and Exchange Commission (SEC) approved the first Bitcoin ETF, which tracks the performance of Bitcoin by holding Bitcoin futures contracts.
The Bitcoin ETF provides investors with a convenient and regulated way to gain exposure to Bitcoin without the need to purchase and store the cryptocurrency itself.
The approval of the Bitcoin ETF was a significant milestone for the cryptocurrency industry. It increases institutional adoption of Bitcoin and leads to the launch of more cryptocurrency ETFs. However, the Bitcoin ETF also carries risks, such as the volatility of the cryptocurrency market and the potential for regulatory changes.
Exchange Traded Product vs Exchange Traded Fund
Exchange Traded Product is a broader category that includes different financial securities traded on an exchange. It tracks the performance of an underlying asset or index. Exchange Traded Fund (ETF) is a specific type of ETP. These are investment funds with a diversified portfolio of underlying assets.
Here are some critical differences between them:
- Types: Exchange Traded Products like ETFs, Exchange-Traded Notes, and Exchange-Traded Commodities can take different forms. Whereas ETFs are a specific type of ETP.
- Underlying assets: Exchange Traded Products can track the performance of a diverse range of underlying assets or indices. Commodities, currencies, or bonds are its best examples, whereas ETFs typically hold a diversified portfolio of stocks or bonds.
- Structure: ETFs are like investment funds. Their value is based on the underlying assets' net asset value (NAV). In contrast, other types of Exchange Traded Products may have different structures. For example, ETNs are debt instruments or ETCs, which may hold the physical commodity or use derivatives.
- Liquidity: ETFs are generally more liquid than other types of ETPs. They trade on an exchange throughout the trading day and have tight bid-ask spreads. In contrast, different ETPs may be less liquid and have wider bid-ask spreads.
- Expense ratios: ETFs typically have lower expense ratios than other types of mutual funds. They have lower transaction costs. Due to their underlying structures, different Exchange Traded Products may have higher expense ratios.
Frequently Asked Questions (FAQs)
ETFs are Exchange Traded products that trade on an exchange like stocks. These typically have lower expense ratios than mutual funds. Mutual funds are not on exchange but priced at each trading day's end.
Exchange Traded Products can track the performance of a diverse range of assets. Stocks, bonds, commodities, currencies, and stock market indices are its best examples.
Yes, Exchange Traded Products are available for trading on an exchange. This makes them suitable for short-term trading strategies. However, investors should consider the risks and costs of short-term trading before investing.
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