Find out more about exchange-traded products (ETPs), their benefits and risks.
Exchange traded products (ETPs) follow an index or invest in resources. ETPs can allow you to invest in a range of markets and be cheaper than other products, but they are not suitable for all investors.
An ETP is an investment product which owns shares in, or is exposed to the performance of shares of, companies in an index (like the FTSE 100), or to the price movements of other investments such as oil or gold.
Most ETPs try to follow the performance of an index to produce the same investment return. Some of the indexes they follow are well known, such as the FTSE 100, but others are less well known. Funds which follow these strategies are commonly known as passive, or tracker funds.
ETPs are also traded on stock exchanges. So you can buy or sell shares in an ETP at any time when the relevant market is open.
The term ‘ETP’ includes a wide range of products which increasingly invest in riskier and more exotic stock markets. This means that investors could potentially make more money but may also lose more money as well.
Different types of ETP investment strategy
Some ETPs buy and hold some or all of the shares, or securities, listed in the index they are tracking. This approach is known as a physical investment strategy because the ETP buys the actual securities which make up the index and whose price it wants to track.
Other ETPs use special transactions, known as swaps, to track the price of the index. The ETP reaches an agreement with a bank that it will pay the fund the same amount that the index returns. This is known as a synthetic investment strategy. It is usually cheaper than buying all the securities in an index and is useful, for example, in less developed markets where the shares are not always available to buy and sell.
These types of ETP depend on the bank being able to keep to its agreement. Your investment may be at risk if the bank is not able to pay. 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.
Benefits of ETPs
Buying ETPs allows you to invest in a range of markets that may be difficult to access directly. They can be cheaper than some other investment products. But other investment products can also provide similar benefits in terms of variety of investment choice and cost. The main difference between these products and ETPs is that is you can deal in ETPs on a stock exchange at any time when the market is open.
Different types of ETP
ETPs have different characteristics and you need to consider these carefully.
- indices: ETPs track different indices and each index has different risks. Some ETPs may track a market that is difficult for some investors to understand. For example, an ETP tracking the FTSE 100 will have very different risks and returns from an ETP tracking the price of gold or an emerging market, such as India
- complex investment strategies: some ETPs use complex financial techniques, including borrowing money to increase returns. This may increase the return, but will also increase the risk and means that these types of fund are not suitable for most people
- legal structures: Exchange traded funds (ETFs) are the most popular type of ETP in the UK. These provide greater protection to investors as they as they must comply with the EU rules for investment funds, known as the UCITS Directive
There are other types of ETP funds, known as exchange traded notes (ETNs) or exchange traded commodities (ETCs). These do not comply with the UCITS rules so offer less investor protection and can use complex financial techniques, which increase risks for investors. These are not suitable for most people.
Before you invest in ETPs
If you are considering investing in ETPs, make sure you ask yourself:
- Is the market I want to invest in suitable for my investment goals?
- Is tracking an index the best way for me to invest in this market?
- Do I understand the risks I am taking compared to the other investment options I have?
- Do I need to be able to trade during the day?
- If I choose to buy an ETP, does it comply with the rules (known as UCITS) that protect retail investors?
ETPs may not be suitable for all investors. There are other risks associated with them that include stocklending, collateral and trading an ETP. You should ask if your ETP is exposed to these risks and if it is, or if you are having difficulty understanding ETPs, you should seek professional advice.