ETF, ETN, ETC, ETV..... Are Exchange Traded Products all the same?  

What do you actually get when you buy an Exchange Traded Product? The comments below relate to an EU, perhaps more specifically British, environment.

All are securities traded on stock exchanges and as such it may make little difference to the investor what actually underpins them. It is only in conditions of financial meltdown that differences might come to seem more important.

An Exchange Traded Fund is perhaps the most robust form. The shares bought and sold must correspond to UCITS III investments. There seem to be 2 forms of ETF:

  1. The Fund holds shares directly attributable to the index being tracked. This means that the ETF investor could, theoretically, demand a parcel of shares attributable to the Fund's shares that he holds. Holding shares may involve a Fund in increased costs, both trading and tax, as it changes the amount and composition of stock (rebalancing) to reflect market activity.

  2. The second means the Fund holds other investments as collateral whilst mimicing the movement of the market through swaps and other derivatives. Using derivatives may involve lower costs and allow the Fund to more closely mimic the index. However the UCITS III structure permits the investor to be exposed to up to 10% of Counterparty risk.

The other fundamental type of Security is the Exchange Traded Note (ETN) that seems to include ETCertificates, ETCommodities, ETCurrencies, ETV (Exchange Traded Vehicle). An ETN is at its simplest a zero coupon note, with redemption date, issued by a bank. Although bought and sold on Stock Exchanges just like an ETF it can leave the investor exposed to the credit risk of the issuing bank.

Instead of interest, the bank promises to repay the note at a rate matching the chosen Total Return index - in other words incorporating dividends etc. The upside of an ETN is its potentially lower costs. The issuer incurs none of the costs of purchasing the underlying assets so an ETN might be expected to track an underlying index without tracking error. The downside for buyers became apparent in September 2008 when Lehman Brothers, an issuer of three ETNs, collapsed and investors became unsecured creditors.

There are variants on the ETN theme that seem to mitigate counterparty risk. For example:

  • Lyxor however declare that they have eliminated credit risk because their ETNs are guaranteed by its parent Societe Generale and 100% collaterised with AAA rated UCITS III funds or Government Bonds. Their Notes are, according to Euronext, a 'senior and unsubordinated debt security'. They say that returns on their ETNs are treated as Capital Gain in the UK.

  • According to Euronext ETF Securities are issuing Exchange Traded Vehicles (ETV). These are described as a 'secured, undated, zero-coupon note' that track the price of an asset (a commodity). They are apparently distinguished by being lendable and marginable.

The conclusion?

ETFs backed by shares should be most secure. Holders of UCITS III security backed ETFs might be liable to a 10% loss in case of a counterparty failure. The Press in autumn of 2008 reported the potential instability of some issuers, and the pricing of some ETNs for a while ceased to track the value of underlying assets, but rather the risk that had until that time been inherent but unrecognised. Do the Special Purpose Vehicles frequently mentioned now offer adequate protection.... Do please let us know<?

Can you provide additional insight? If so please email us.


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