ETPs’ popularity spawns a proliferation of acronyms

This article is part of
Growth in Exchange-Traded Funds - April 2014

But the expansion of this universe into areas such as commodities and unsecured debt instruments means the once simple ETF acronym has been expanded to include ETCs (exchange-traded commodities), ETNs (exchange-traded notes) and the ‘catch-all’ term ETIs (exchange-traded instruments).

For many the terms are interchangeable, with Mark Johnson, head of iShares sales in the UK, noting that one of the reasons for the different names is simply that some structures make more sense than others when looking to access certain types of asset class.

He adds: “At the end of the day, they are giving you that benefit of exchange liquidity, transparency and low cost. That is why they are often used.”

Arne Noack, head of exchange-traded product development, EMEA, at Deutsche Asset & Wealth Management, highlights the proliferation of three-letter acronyms.

He explains: “Exchange-traded products (ETPs) is an umbrella term that typically refers to secured [meaning backed by assets], exchange-traded equity or debt instruments.

“ETFs and ETCs typically fall into this category. ETNs are different, because they are typically unsecured debt instruments ‘issued’ by banks, so ETNs are generally placed in a different category from ETFs and ETCs.”

Mr Noack points out that investors in ETNs bear counterparty credit risk to the issuing bank. ETFs and ETCs are designed to minimise counterparty risk, either through the purchase of physical assets or via the posting of collateral with an independent third party, while ETNs, on the other hand, typically come with full counterparty risk to the issuing institution.

Currently, commodity markets are less popular with investors on the back of falling gold and oil prices, but for those still interested in the sector but not wanting to invest directly, then ETCs are one option.

“One question sometimes asked is why ETFs, the original listed-tracking products, have not been designed to track the performance of commodity indices,” says Mr Noack. “The answer, in Europe at least, is that for index-tracking products to qualify as a fully regulated ETF, the fund must reference a diverse basket of underlying securities. European ETFs therefore, if they are to comply with EU directives, cannot track single commodities or highly concentrated indices.

“Providers of index-tracking products therefore faced a challenge in coming up with instruments that would provide investors with the beneficial elements of an ETF – listed, liquid, tradable and cost effective – but would give exposure to a single commodity or commodity price index. The answer was the ETC.”

However, the exchange-traded industry is not content with equities, fixed income, commodities and debt. The results of the EDHEC European ETF Survey 2013 suggest product development within certain asset classes has driven increases in ETF usage, notably within real estate, hedge funds and infrastructure.

The findings also noted that 39 per cent of the respondents were interested in further development in ETFs based on smart beta indices.

In a market with so much potential, particularly in the UK and Europe, the next innovations in the passive market seem to be just around the corner.