1 Exchange Traded Products The differences between ETFs & ETNs & ETCs
Dec 23, 2015
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Exchange Traded ProductsThe differences between ETFs & ETNs & ETCs
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What are Exchange Traded Products?
Exchange Traded Products (ETPs)
Fastest growing product class traded on an exchange Cost effective access to an asset class Available on a wide range of equity & fixed income indices and single commodities Comprised of ETFs, ETNs, (and ETCs)
Exchange Traded Funds (ETFs) are mutual funds and can be: Physical ETFs - which hold the index securities Swap-based ETFs - which replicate the index performance through the use of swaps
Exchange Traded Notes (ETNs) are debt instruments: There are several sub-categories, such as Exchange Traded Commodities (ETCs) Often ETNs are used to offer exposure to assets that can not be achieved with a fund, for example
single commodities
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Global ETP Growth
Source: ETF Research and Implementation strategy team, BGI, Bloomberg. As of April 2009
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Why are there different legal structures?
Many investors prefer a mutual fund structure
Investor protections & regulations UCITS, SEC 1940 Act, Unit Trusts, OEICs, etc… Governed by a Prospectus, with regular accounts and reports Portfolio is mutually owned by investors, not product provider
Familiarity & comfort of structure Majority of Retail assets held in pooled products are in mutual funds
Some asset classes are not available in a mutual fund structure
Single Commodities Foreign exchange Options strategies
Principal protected investments Buy/write or covered call
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How do Physical ETFs obtain their economic exposure?
Source: Barclays Global Investors1 Fund domiciled and managed in Germany2 Subfund of iShares plc managed in Ireland3 Subfund of iShares II plc managed in Ireland4 Subfund of iShares III plc managed in Ireland.
All holdings are published on a daily basis on www.ishares.com
% Name Market price
Country
6.53 TOTAL SA 40.67 France
5.04 TELEFONICA SA 16.08 Spain
4.28 BANCO SANTANDER SA 7.00 Spain
4.07 E.ON AG 28.88 Germany
3.70 SANOFI-AVENTIS 46.82 France
3.36 GDF SUEZ 34.00 France
3.32 ENI SPA 17.83 Italy
3.30 SIEMENS AG-REG 52.96 Germany
3.24 NOKIA OYJ 11.15 Finland
2.96 FRANCE TELECOM SA 20.37 France
Cash-based ETFs track performance by buying underlying securities
iShares DJ EURO STOXX 503
As at 08/01/2009
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How do Swap based ETFs obtain their economic exposure?
iShares Dow Jones STOXX 600 Telecommunications Swap (DE)1
As at 31/03/2008
Swap Based ETFs „outsource“ index tracking by entering a swap agreement Swap-based ETFs buy securities In addition a swap is structured
Holdings for swap-based funds are published in annual reports
Equities # of shares in 1000
Weight
Adidas AG 85,204 4.27
Allianz SE 31,760 4.74
Assicurazioni Generali 130,742 4.43
BASF SE 42,823 4.35
Bayer AG 65,464 3.96
BNP Paribas S.A. 61,569 4.68
Carrefour S.A. 80,459 4.68
Commerzbank AG 188,806 4.45
Continental AG 56,161 4.32
Daimler AG 71,611 4.62
Basket + Swap
Source: Barclays Global Investors1 Fund domiciled and managed in Germany2 Subfund of iShares plc managed in Ireland3 Subfund of iShares II plc managed in Ireland4 Subfund of iShares III plc managed in Ireland
Swap CounterpartyETF
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ETF Swap Mechanism
Equity basket performance: increase from €100 to €105
ETFSwap
Counterparty
Total return index performance: increase from 100 to 107
Payments from swap agreement
Leg II pays €7
Leg I pays €5
Swap-based ETFs buy securities i.e. Swap-based Sector iShares buy basket of liquid stocks of DJ Global 1800 universe
In addition a swap is structured Leg I: pays performance of equities Leg II: receives performance of total return index, that is tracked
- 5€ + 7€ = +2€
ETF NAV:105€ + 2€ = 107€
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How do ETNs obtain their economic exposure?
The ETN is a debt obligation of the issuer that is linked to a derivative. An ETN looks similar to a Swap based ETF, except there is no basket of securities.
Differences between Swap based ETF & an ETN:
Legal structure (Fund vs. Debt) Collateralization
UCITS are required to collateralize 90% of counterparty exposure Notes may use collateral, but are not required
Why does the swap matter?
Counterparty risk in the derivative contract (swap) Variable cost of swap paid to counterparty over time, not in the TER (a “swap spread”) Creates a single dealer trading model for the ETN/ETF shares on exchange
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How to quantify counterparty risk
The cost of buying protection against default is the CDS spread
Credit Default Swaps (CDS) ensure against default of a counterparty
Source: Barclays Capital, as at 13/01/2009
0
25
50
75
100
125
150
175
200
225
250
275
Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08
Cre
dit
Def
ault
Sw
ap S
prea
d in
bps
Hypo-Vereinsbank AG Subordinated 1Y CDS (185.31 bps as of 13/01/2009) Societe Generale Subordinated 1Y CDS (121.56 bps as of 13/01/2009)
Deutsche Bank AG Subordinated 1Y CDS (217.80 bps as of 13/01/2009)
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Why does this matter?
Swap based ETFs & ETNs can be creditors to the Counterparty.
Corporate action on Counterparty can greatly reduce liquidity.
September 15 – 19th, 2008 highlighted Counterparty risks in ETPs
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Gold on Tuesday (16/09/2008): No Bid or Offer
Source: Bloomberg
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Gold on Friday (19/09/2008): Still No Bid or Offer
Source: Bloomberg
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Examples of each type of ETP structure
Physical-based Derivative based
ETFs All iShares Dublin domiciled ETFs, e.g.- iShares FTSE 100- iShares £ Corporate Bond- iShares Index Linked Gilts etc
CS XMTCH
Lyxor
db x-trackers
iShares DE SWAP sector
ETNs Gold Bullion Securities ETF Securities (other)
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Comparing ETFs and ETNsPart 1
Exchange Traded Funds (ETFs) Exchange Traded Notes (ETNs)
Exchange listed Yes Yes
Easy accessible investment vehicles for a range of asset classes
Yes Yes
Low Tracking Error Yes Yes
Low costs Yes Mostly
Exposure to market risk of the asset class / index
Yes Yes
Structure Mutual Fund Note
UCITS Fund Mostly No
Underlying holdings Index securities for physical ETFs
Index swap plus a basket of non-index securities for
swap-based ETFs
N/A
Source: BGI
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Comparing ETFs and ETNsPart 2
Exchange Traded Funds (ETFs) Exchange Traded Notes (ETNs)
Fund/note issuer risk No,mutual funds hold assets in ring-fenced segregated
accounts or ring-fenced fund company
Yes, bears exposure to credit worthiness of
note issuer
Swap counterparty risk No,for physical ETFs
Yes, for swap-based ETFs
limited to 10% under UCITS and sometimes reduced
further through ETF provider
No
Other counterparty risk considerations
Securities lending activity and collateralization of such activity
Some notes are backed by collateral or guarantees to decrease issuer risk
Transparency Yes, Full holdings disclosed for
physical ETFs
Limitedfor swap-based ETFs
Limited
Competitive Multi Dealer Model to trade on and off exchange
Yes, for physical ETFs possible
Limited,for swap-based ETFs
Limited
Source: BGI
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Disclaimer
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