Difference between ETPs vs ETFs Complete Guide

Among the many available instruments for investments, there are numerous ways through which investors can increase their wealth in the financial markets. Two of the most prominent ways include Exchange-Traded Products and Exchange-Traded Funds. While the two tools share many similarities, they are also quite different in some aspects. Investors should know the main differences between ETP and ETF in order to make any decisions which best suit the finance-related goals. We will identify, in this article, major differences between ETPs and ETFs by focusing on structure, types, benefits, and risks.

Understanding Exchange-Traded Products (ETPs)

What is an ETP?

An ETP, otherwise known as an exchange-traded product, makes this investment security generally closer to any other stock. It can track basic stocks and bonds, commodities, and currencies, or even a combination. They allow an investor exposure to the performance of different assets without really owning them. There are various types of ETPs: Exchange-Traded Funds (ETFs), Exchange-Traded Notes (ETNs), and Exchange-Traded Commodities (ETCs.

Types of ETPs

Exchange-Traded Funds (ETFs): ETFs are the most common type of ETPs. They are investment funds that hold a diversified portfolio of assets and trade on an exchange throughout the trading day. ETFs can track indices, sectors, commodities, or bonds.
ETNs (Exchange-Traded Notes): ETNs are debt securities which a financial institution issues. Unlike ETFs, ETNs do not have any portfolio of assets. On the other hand, ETNs guarantee returns corresponding to the performance of some index or benchmark. In contrast to ETFs, ETNs are less fees. ETNs are subject to credit risk since they are backed solely by the issuer’s creditworthiness.
Exchange-Traded Commodities: They are funds that provide investors with an exposure to commodity markets such as gold, oil, agricultural products, or other commodity markets. They can be physically backed or based on commodity indices.

Benefits of ETPs

Liquidity: Since ETPs are traded on exchanges, this allows investors to buy and sell at any time during the trading day at market prices.
Diversification: ETPs provide access to a diversified portfolio across asset classes, sectors, or markets, thus helping investors to diversify their portfolio.
Transparency: The holdings of ETPs are generally disclosed on a daily basis, thus providing transparency to the investor.
Cost Efficiency: Most of the ETPs have lower expense ratios compared to mutual funds, thus making them quite cost-effective for investment.

Risks of ETPs

Market Risk: The value of an ETP will fluctuate with changes in the market value of the underlying asset held, which may involve potential losses for investors.
Tracking Error: ETPs do not track their underlying indices or benchmarks perfectly; therefore, there will be discrepancies in performance.
Credit Risk (ETNs): ETNs are subject to the possibility that the issuer may default on its obligations under the note and thus result in loss for investors.

Understanding Exchange-Traded Funds (ETFs)

What is an ETF?

An Exchange-Traded Fund (ETF) is an investment fund with a basket of different assets—this may be stocks, bonds, or commodities—listed and trading on a stock exchange. It is an investment fund designed to track the performance of a particular index or benchmark, thus giving investors exposure to the assets within the index. They can be passively managed, whereby the ETF aims to replicate the performance of an index, or actively managed, whereby the fund manager chooses assets with a view to outperforming the market.

Types of ETFs

Equity ETFs: It involves investing in a basket of equities that track indices such as the S&P 500 or NASDAQ-100. They provide exposure to the performance of a broad market or specific sectors.
Bond ETFs: These are bond ETFs that enable investment in a portfolio of fixed-income securities, which may be government bonds, corporate bonds, or municipal bonds. They provide an investor with exposure to the bond market and the liquidity associated with trading in stock.
Commodity ETFs: It invests in real commodities or even future contracts, hence partaking in either upward or downward price movements in commodities such as gold, oil, or agro-based products.
Sector and Industry ETFs: These are ETFs focused on certain sectors or industries, such as technology, health care, or energy. They enable investors to concentrate investments in those areas they believe have the best potential to rise above the broader market..
International ETFs: These international ETFs invest in securities outside an investor’s native country, letting them get exposure to worldwide markets.
Inverse and Leveraged ETFs: The inverse ETF is designed to move opposite to the underlying index, while the leveraged ETF uses financial derivatives to exaggerate the returns of the index, usually on a daily basis.

Advantages of ETFs

Liquidity: Since they are trade on exchanges, it allows investors to buy and sell ETFs throughout the trading day at real-time prices.
Diversification: This tool provides broad diversification across asset classes, sectors, and geographic regions to any investor.
Cost efficiency: The investment in ETFs is cost-effective; it has a lower cost as expense ratios are less compared to mutual funds.
Transparency: Most ETFs disclose their holdings daily to the investors. This makes it very transparent with respect to the fund’s assets.
Flexibility: It can be used for long-term investing, hedging as well as for speculation.

Risks of ETFs

Market Risk: As the ETFs may change value as per the underlying asset performance, it may translate to potential losses for the investor.
Tracking Error: Since ETFs usually hold most of the securities of their related index, their performance may not track perfectly with the underlying indices.
Liquidity Risk: The ETFs are generally liquid, but some of them that have exposure to less liquid assets will have wider bid-ask spreads and reduced liquidity.

Key Differences Between ETPs and ETFs

While ETFs are actually a subset of ETP, not all ETPs are ETFs. Some key differences that set them apart are as below..

1. Structure

ETPs: Basically, an ETP is a general class of any security that trades on an exchange. It includes ETF, ETN, and ETC. It could be in the form of a fund, debt, or commodity.
ETFs: They are another type of investment fund that holds a basket of assets whereby they trade on an exchange. Normally, they either take the form of open-end funds or unit investment trusts.

2. Underlying Assets

ETPs: Under the can be an extensive variety of assets which include shares, bonds, commodities, currencies,; or a combination.
ETFs: ETFs generally follow a specific index or benchmark that focuses on a single class of assets, such as equities, bonds, or commodities.

3. Risk Profile

ETPs: Different classes of ETPs have different risk profiles. An example is ETNs, which carry credit risk since they are debt instruments, while ETFs have market risk based on the performance of the underlying assets.
ETFs: Primarily carry market risk tracking the performance of the assets within the fund. However, it does not have the credit risk associated with ETNs.

4. Purpose and Use Case

ETPs: ETPs can be used for hedging a position, for investment with a view to generate income, and for speculation. There are various types of ETPs according to the investment goals.
ETFs: These are long-term instruments or portfolios that diversify the risk of an investor and allow the investor exposure to an target drisk market or sector. They also make up a core of both passive and active investment strategies.

5. Regulatory Framework

ETPS: Strictly naturally, this means that ETPS are hedged against different regulatory frameworks. For example, ETFs are regulated under the Investment Company Act of 1940, while ETNs are normally issued as debt securities under the Securities Act of 1933.
ETFs: This makes them subject to the requirements for a fund’s operation in the Investment Company Act of 1940, in the areas of transparency, diversification, and governance.

Choosing Between ETPs and ETFs

When deciding between ETPs and ETFs, investors should consider their investment objectives, risk tolerance, and the specific characteristics of each product. Here are some factors to consider:

1. Investment Goals

Long-Term Growth: If you are looking to invest for long-term growth and would like to further diversify your portfolio, then ETFs would be more suitable, as they are diversified themselves, and their expense ratio is low.
Hedging and Speculation: ETNs or leveraged/inverse ETPs will be used when one wants to hedge from the market movement or speculate on the performances of various assets. However, such activities carry higher risks.

2. Risk Tolerance

Expense Ratios: The expense ratios for most ETFs are lower compared to that of the other ETPs, thus suitable for long-term investors and those seeking cost efficiency.
Trading Costs: Consider the trading costs that will be incurred while buying and selling ETPs, such as the bid-ask spreads and commissions.

3. Cost Considerations

Low to Moderate Risk: If you have low to moderate risk tolerance, you should opt for ETFs that track broad market indices, which generally have lower volatility.
Higher Risk: If you can tolerate higher risk, then ETNs or leveraged ETPs may deliver stronger potential returns; these ETPs are also associated with increased volatility and the potential for extensive losses.

4. Tax Efficiency

ETFs: Due to their unique structure that allows in-kind redemption, thus reducing the impact of capital gains distributions, ETFs are generally more tax-efficient than mutual funds.
ETPs: Tax efficiency can vary depending on the type of ETP. For instance, ETNs are not paying dividends or interest in some cases; therefore, they may be more tax-efficient.

Conclusion

There are a great variety of choices available for investors within ETPs and ETFs to build and manage portfolios. While one of the ETPs is an ETF, the latter also holds other financial instruments, including ETN and ETC. Each of them is different from the other, carrying their particular attributes and risks. It thus becomes very important to understand the difference between an ETP and an ETF in order to make any investment decision in line with your financial goals. Be it for long-term growth, income generation, or a hedge and speculation strategy, there’s likely to be an exchange-traded fund or an ETP that will fill your needs. As always, do your homework and consult a financial advisor in making any decisions about investments.