Exchange-Traded Products (ETPs)
Benefits of Investing in Exchange-Traded Products
Exchange-traded products (ETPs) are similar to mutual funds in that they’re made up of a basket of securities. For ETPs, those securities include stocks, bonds, commodities, or indices. The main difference between exchange-traded products and mutual funds is that ETPs are traded like individual stocks on an exchange.
The benefits of investing in exchange-traded products include:
- Buying and selling flexibility -- ETPs are priced and can be purchased and sold throughout the trading day, and you can buy or sell ETP shares on a stock exchange much like the purchase or sale of any other listed stock.
- Portfolio diversification -- ETPs can track a wide variety of sector-specific, country-specific, and broad-market indexes. They may provide diversification to your overall portfolio, because one share or one unit may represent multiple underlying stocks, bonds, and/or other asset classes.
- Expense ratios -- In general, underlying fees and expenses are low. Non-traditional and actively managed exchange-traded products will generally have higher fees than traditional ones.
- Tax efficiency -- Traditional exchange-traded products are generally not actively managed and, as a result, typically generate fewer capital gains due to the low turnover of the securities within their portfolio. However, taxes must be paid on all distributions made by the underlying securities and any capital gains associated with transactions made by the fund.
- Transparency -- The securities in most ETP portfolios are made public every day. Because these securities generally trade within an index or sector that the ETP follows, you may be able to determine the positions within the portfolio at any time. You may find this beneficial because the transparency could allow you to have more control over your overall investment portfolio allocation and weightings.
Types of Exchange-Traded Products
Exchange-traded products encompass a number of investment structures that track an underlying benchmark, index, or portfolio of securities. These include exchange-traded funds, exchange-traded notes, grantor trusts, or commodity pools.
Exchange-Traded Funds (ETFs)
Exchange-traded funds are the most popular of the exchange-traded products and the most recognizable. While many investors have heard of ETFs (with “exchange-traded products” being a lesser known term), they may not realize that ETFs are a category of exchange-traded products and that their characteristics are different than the other categories.
ETFs typically hold a basket of equity or fixed-income securities and are constructed to track an index. The majority of ETFs are structured as registered unit investment trusts (UITs) or open-end investment companies whose shares represent an interest in a portfolio of securities that track an underlying benchmark or index.
Investors often choose to invest in ETFs to take advantage of the diversification they provide.
An exchange-traded note is a common name for a senior unsecured debt obligation designed to track the total return of an underlying index or benchmark – without investor fees. They are not registered investments and do not have the same protections as registered investment companies. They don’t offer principal protection unless it’s specifically stated in the prospectus, and the repayment of principal, interest (if any), and the payment of any returns at maturity or upon redemption are dependent on the issuer’s ability to pay.
Exchange-traded notes are listed on an Exchange and can be sold throughout the day. Some nontraditional exchange-traded notes seek to track the leveraged or inverse performance of an index. Similarly, commodity futures-linked exchanged-traded notes seek to track a commodity or currency index. These unique nontraditional and commodity futures-linked exchange-traded note products also share many of the same risks and characteristics as nontraditional exchange-traded products.
Grantor Trusts and Commodity Pools
Exchange-traded products that hold commodities, currencies, commodity- or currency-based instruments, or volatility instruments may be structured as grantor trusts or commodity pools, depending on the type of underlying instrument.
Exchange-traded products that hold physical bullion or currency are typically structured as grantor trusts. If you’re a "buy and hold" investor, you may want to consider grantor trusts.
Commodity pools are exchange-traded products that gain exposure to commodities or other asset classes through the use of futures or forwards contracts. If you’re looking to gain access to the futures and commodities market, you may want to consider investing in a commodity pool.
Grantor trusts and commodity pools are not registered companies, so they do not have the protections as those ETPs registered under the Investment Company Act of 1940. Tax consequences vary depending on the structure and underlying instruments used in each exchange-traded product. Talk with your tax advisor to determine how they would affect you.
Risks of Investing in Exchange-Traded Products
Exchange-traded products are subject to risks similar to those of stocks. Investment returns may fluctuate and are subject to market volatility so that an investor's shares, when redeemed or sold, may be worth more or less than their original cost.
Shares of ETPs are bought and sold at market price, which may differ significantly from the ETP's net asset value, and are not individually redeemed from the fund. Only "authorized participants" can purchase and redeem directly in the funds creation units, typically consisting of a block of 50,000 shares. Ordinary brokerage commissions for purchases and sales may apply, which could reduce returns.
How We Can Help You Invest in Exchange-Traded Products
Contact your Financial Advisor to learn more about the advantages and disadvantages of investing in exchange-traded products and to discuss whether these investments fit within your overall investment portfolio. You can also read our “Guide to Investing in Exchange-Traded Products” (PDF) for more information.
Exchange-traded products are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information, can be obtained by calling your Financial Advisor. Read it carefully before you invest.