What is the difference between ETFs and ETPs?

by

Jack Derwin

January 24th 2022 3 minute read
They might sound almost identical but investors shouldn’t conflate ETFs with ETPs. For investors starting out in the market, it pays to know the difference.

What is an ETP?

An exchange-traded product, or ETP, is an umbrella term used for a variety of different investments that trade on a public exchange.
Popular exchange-traded funds (ETFs) for example are a type of ETP but an ETP isn’t necessarily an ETF.

Generally speaking however, ETPs have some common traits. Generally, they are easily bought and sold in a single transaction on a public exchange such as the ASX or the New York Stock Exchange (NYSE) and are typically low-cost.

These attributes, among others, have made ETPs very popular among investors of all stripes.

What is an ETF?

ETFs are the best known form of ETPs and do exactly what they say on the tin.

They are funds that – much like a stock – are traded via public exchanges such as the ASX. This means they can be bought or sold at any time the market is open and you can see at what price people are buying or selling them at.

ETFs typically hold a bucket of companies filtered by a certain theme or criteria, whether that is the largest 200 public companies in the United States or a select group of large cybersecurity stocks. In this sense, they can provide some instant diversification for new investors.

But as their popularity has swelled, so has the number of ETPs available.

The different types of ETPs

Index funds

When a fund tracks a specific subset of the market such as the ASX 200 – containing the 200 largest Australian-listed companies by market cap – they are also known as index funds.

As a company’s fortune rises or falls it can enter or exit an index fund or come to represent a larger slice of it. Other than that however, there’s no reshuffling of a fund’s holdings with the fund’s intent to reflect the index itself.

Active ETFs

Actively managed ETFs, also known as ETMFs, on the other hand are overseen by investment managers who try to optimise their investment returns and ‘beat the market’. As a result, these often carry higher management fees and sometimes higher risk.

Inverse ETPs

Just as conventional ETFs can be used to track an index, an inverse fund can be used to bet against one – or a specific investment. Gaining popularity in 2020 as the pandemic introduced a degree of uncertainty to the market, these ETPs produce a positive return when the corresponding investment produces a negative one and vice-versa.

In other words, investors can use them to bet against a market or company. However, they are often used as a means of short-term speculation rather than as part of a long-term investment strategy.

Geared ETPs

Geared funds on the other hand don’t try to replicate an asset’s returns but rather magnify it. Through borrowing, the fund increases its exposure and tries to multiply the underlying return by a factor of two or three for example. Equally, it will also multiply any potential losses.

Just as with any investment, the greater potential reward corresponds to the greater risks inherent to this type of ETP. Investors should be careful about these products, their volatility and their downside risks.

Structured or synthetic ETPs

Unless otherwise stated, ETFs typically own the assets they seek to track. For example, an ASX 200 index fund will generally own shares in each of the top 200 Australian companies.

However, there are other products known as structured or synthetic ETPs or ETFs where the fund doesn’t actually own the asset itself.

These instead trade derivatives or price contracts. These are commonly used by commodity ETFs where it would be expensive and burdensome to have to transport and store a physical asset like gold every time the fund trades it.

Instead a synthetic ETF makes a trade based upon the price of the asset to produce a return. These types of ETPs tend to carry additional risks as a result.

Always understand your investment

As the list above demonstrates, there are many types of ETPs available on the market with more and more added each year. While products like ETFs have proven popular with many investors, some of those available are riskier than others. It’s crucial then that investors understand exactly what they are buying before they invest in it.