ETPs usually follow the price movements of a financial index or benchmark (e.g. the FTSE 100) and can offer an alternative way to gain exposure to a wide range of markets, without incurring all of the costs of investing directly.
What is an Exchange Traded Product?
There are three types of ETPs:
Exchange Traded Funds (ETFs)
ETFs are the most common type of Exchange Traded Product seeking to follow a sector, market or index. They trade like specific stocks on recognised exchanges, allowing mainstream investors to gain exposure to specific markets/indices easily. Plus, an ETF offers real-time exposure to an asset class, region, country or business sector thanks to the constant stock market listing, for example if an investor decides to gain exposure to the Brazilian market, this can be done regardless of the opening or closing hours of the local stock exchange.
ETFs can provide greater protection to investors than other ETPs as they can comply with the EU rules for investment funds, known as the ‘UCITS’ Directive (the directive imposes certain requirements on funds with regards to the level of portfolio diversification, rules regarding segregation and protection of fund assets and restrictions on the types of assets that can be bought (e.g. commodities)). However, not all ETFs are eligible for a UCITs licence.
Exchange Traded Commodities (ETCs)
ETCs are products that are listed and traded on a stock exchange, however, unlike ETFs, which will generally track equity or fixed income indices, ETCs track commodity indices, such as metals, natural energy resources, agricultural produce or livestock. In some cases an ETC will try to directly track the performance of a given commodity, in other cases ETCs will track an index that is designed to measure the value of that commodity.
ETCs do not comply with the UCITS rules so offer less investor protection and can use complex financial techniques which increase risks for investors (please see risks).
Exchange Traded Notes (ETNs)
ETNs are unsecured debt obligations typically issued by a bank or other financial institution. ETNs do not usually pay any interest payments, instead the issuer promises to pay the investor an amount determined by the performance of the underlying index or benchmark, less any specified fees at maturity.
Additionally, ETNs can be traded on exchanges at prices set by the market similar to equities or ETFs.
ETNs do not actually hold assets to replicate the performance of the underlying index. They can be complex and include the risk that the issuer will default on the note or take other actions that may impact the price of the ETN.
ETN’s do not comply with the UCITS rules so offer less investor protection and can use complex financial techniques which increase risks for investors (such as borrowing).
Although each has distinct structural differences, they generally follow the price movements of a market, whether they are tracking indices, commodities, basket of shares or FX rates. ETPs allow you to invest in a wide range of investments and markets. However, they vary by investment market, investment strategy, legal structure and risk.
ETP Risk Warning
ETPs can use complex financial techniques, meaning that these types of products may not be suitable for all investors. The value of an ETP is not guaranteed and can go down as well as up and you may get back less than you invested. If you are unsure of their suitability please seek independent financial advice. The protections available under the Financial Services Compensation Scheme (FSCS) may not be available for all types of ETPs domiciled outside of the UK.
Before you invest in an UCITS ETF you should make sure that you read the Key Investor Information Document (KIID) and Key Features Document (KFD) or other supporting information. For other types of ETP you should make sure that you read the Prospectus for the ETP you are intending to invest in, to make sure that it fits in with your investment goals. In addition, other information might be available like a fact sheet.
More risk information
The documented risks below are not intended to be an exhaustive list associated with ETPs, however, documents the more common risks associated with these types of products.
Tracking error is the difference between the performance of the ETP and the investment it tracks. Tracking error depends on the market conditions at the time and can either be in the client’s favour or against them.
Certain ETPs use complex financial products such as swaps (see synthetic ETP for details), futures and options with other third party counterparties rather than purchasing the assets themselves to achieve investment performance. If the investment bank providing these complex products fails, the ETP may lose a part or all of the funds they had invested.
Investors should consult the ETP’s prospectus to understand the Counterparty risk associated with the product.
Stock lending (collateral)
ETP providers can generate further revenue by lending their holdings (collateral) out to other third party institutions, such as investment banks. If these third parties fail and the holdings are unable to be recovered, investors could suffer a potential loss. Different ETPs have different exposures to stock lending and the ETP prospectus should be consulted to determine the Collateral Policy for that product.
If the ETP’s underlying holdings are in a currency different to the denominated currency, investors will be affected by fluctuations in foreign exchange rates.
Leverage & Short ETPs Risk
The more an ETP invests in leverage derivative instruments, the more this leverage will magnify any losses on these investments. For leverage index-based ETPs, the value of the ETP’s shares will tend to increase or decrease more than the value of any increase or decrease in its underlying index. ETPs that offer leverage are highly complex financial instruments with a high degree of risk and are not suitable for all investors. Investors should carefully consult the prospectus before investing so they understand the risks associated with these products before trading.
In certain circumstances, it may be difficult for an ETP to trade particular investments within a reasonable time at a fair price, which may reduce the ETP’s returns. Also, during periods of reduced market liquidity or in the absence of readily available market quotations for particular investments in the ETP’s portfolio, the ability to produce an accurate daily value to these investments may be difficult.
To the extent that an ETP’s Underlying Index or portfolio is concentrated in the securities of a particular market, country, industry, sector or asset class, the ETP may be adversely affected by the performance of those securities, subject to increased price volatility and may be more susceptible to adverse economic, market, political or regulatory occurrences affecting that particular market, country, industry, sector or asset class.
The tax treatment of an ETP is determined by your individual circumstances and the continued status of the ETP. The returns from trading ETPs could be subject to income tax rather than Capital Gains Tax. If you are unsure whether an ETP is suitable for your own individual circumstances you should consult a qualified tax advisor.
Other important ETP information
What’s the difference between physical and synthetic ETPs?
If the ETP buys the actual securities or the shares which make up the index and whose price it is tracking, this is known s a physical ETP. For example, a physical commodity such as gold or other precious metals.
A synthetic ETP uses a swap to track the price of the index. This means that the ETP agrees with an underwriting bank that it will pay the fund the same amount that the index returns. This is usually cheaper than buying all the securities in an index. These kinds of ETPs depend on the underwriting bank being able to honour its agreement but if the underwriting bank goes bankrupt then the investment might lose value. There is some protection for you if the bank gives other assets to the ETP to back the agreement, known as collateral, which the ETP can sell if the bank does not pay. Other types of synthetic ETP are also available.
Why trade in Exchange Traded Products?
Convenient - easily traded and continually priced throughout market hours just like shares.
Diversification - over a whole market index or sector, so spreading risk and increasing access to a range of securities.
Access to a wide range of different asset classes – from familiar UK indexes like the FTSE100 to oil and precious metals.
Low cost – ETPs are traded like shares at normal dealing online commission rates, which start from just ?5.95 for active traders. See full rates and charges.
No stamp duty on purchases - depends on the individual circumstances of each customer and may be subject to change in the future.
Key Investor Information Document (KIID)
You can research specific funds using Morningstar data including past performance and fund charts. ETPs may not be suitable for all investors. Before you invest please read the Key Investor Information Document (KIID) and Key Features Document (KFD) or any other supporting documents for the ETP you are considering. If you are unsure then please seek independent advice.
Before making an investment decision on any other type of ETP, you should first consult the ETP’s Prospectus to make sure you are aware of the risks and ensure that the ETP fits in with your investment goals.
Which account should I choose to invest in ETPs?
You can invest in ETPs through our Trading Account, Trading Plus Account, TD Trading ISA, or SIPP Accounts. (Please note some ETPs may not be eligible for an ISA)