Exchange Traded Products
About Exchange Traded Products (“ETPs”)
ETPs are investment products that are listed on a national stock exchange and can thus be bought and sold in the equity trading markets. ETPs encompass a number of structures which track an underlying benchmark, index, or portfolio of securities. ETPs may be structured as registered unit investment trusts (UITs), exchange-traded funds (ETFs), exchange-traded notes (ETNs), grantor trusts or commodity pools.
The majority of ETPs are structured as UITs or ETFs whose shares represent an interest in a portfolio of securities that either track an underlying benchmark or index. In order to achieve their objectives, ETPs generally either (a) directly invest in assets such as stocks, bonds, currencies, or commodities that underlie the benchmark, or (b) utilize a representative sampling strategy that attempts to achieve a similar performance to the benchmark without investing in all of the underlying securities of the benchmark.
A number of ETPs employ, to varying degrees, more sophisticated, financial strategies and instruments such as leverage, futures, swaps, and/or derivatives in order to achieve their investment objectives. Those ETPs are commonly referred to as "Non-Traditional ETPs". Non-Traditional ETPs are more complex than traditional ETPs and may not be appropriate for all investors. These may include some ETNs, leveraged or inverse ETPs, some actively-managed ETPs, futures-linked ETPs, volatility ETPs, and other products.
Passive or Non-Managed ETPs
Passive or non-managed ETPs generally seek to replicate the performance of an index or benchmark that they track. Leveraged ETPs seek to deliver multiples of the performance of the index or benchmark they track. Inverse ETPs seek to deliver the opposite of the performance of the index or benchmark they track.
Most leveraged and inverse ETPs “reset” daily, meaning that they are designed to achieve their stated objective on a daily basis. If held for longer periods of time, their performance can diverge significantly from the performance (or inverse of the performance) of their underlying index or benchmark during the same period. This could lead to increased levels of risk, including without limitation, market risk, volatility risk, liquidity risk, and positive and negative compounding risk. This effect can be magnified in volatile markets.
Generally, futures-linked ETPs attempt to track a futures-based commodity, currency, or volatility index. These ETPs may hold futures contracts, swaps, forward contracts, or other derivatives. They are not the equivalent of investing directly in the actual physical commodity, currency, or volatility instrument. As a result of their complex structure, their performance may not necessarily correspond to the price performance of the underlying investment. This deviation could be positive or negative depending on market conditions and investment strategy.
Actively- Managed ETPs
Actively-managed ETPs do not seek to replicate the performance of a specified passive index of securities. Instead, they use an active investment strategy to attempt to meet their investment objective. An investor’s decision would usually be based on their assessment as to whether the ETP investment manager can select securities that will lead to outperformance versus the benchmark, net of the ETPs fees, over a given market cycle or longer period of time. Actively-managed ETPs typically charge higher fees than ETPs that passively track an index.
Some “Non-Traditional ETPs” may use a volatility component as a part of their overall strategy, while other ETPs may identify exposure to volatility as a primary investment objective. Furthermore, some products may seek inverse, leveraged, or leveraged inverse exposure to the CBOE Volatility Index (VIX). There is no way to invest directly in the VIX, so volatility oriented ETPs must rely on alternate indices that actually reflect the market’s expectation of volatility at some point in the future, rather than providing exposure to the volatility that the markets are experiencing at the present point in time. Volatility ETPs are not based on, nor do they track, the returns of the VIX, and thus the performance of a volatility ETP will not actually mimic the performance of the VIX. The buying and selling of contracts in the futures market, which could result in losses, could adversely affect the value of the Index underlying your ETPs and, accordingly, decrease the value of your investment.
Target Return ETPs
Target Return ETPs are a type of “Non-Traditional” ETP that employ the use of derivatives contracts to provide predetermined return outcomes based on the price performance of an underlying market, such as US equities, Treasury bonds, or commodities, over specific timeframes, known as “Outcome Periods.” Outcome Periods, which vary by product, are point-to-point periods, over which performance of the underlying market is measured, and the product’s upside participation and downside protection features, if any, are applied to achieve the ETP’s stated return objective. To fully achieve a Target Return ETP’s stated return objective, if at all, shares must be purchased at the beginning of the Outcome Period and held until the conclusion of the Outcome Period. Purchases after the Outcome Period has begun, and/or sales prior to the conclusion of the Outcome Period, may result in return outcomes that are significantly worse than the Target Return ETP’s stated objective. These adverse return outcomes may include, but are not limited to, a complete loss of any downside protection and/or little to no ability to participate in future gains of the underlying market. Even when held for the entirety of the Outcome Period, there is no guarantee that the Target Return ETP will achieve its stated return objective. Target Return ETPs, like other ETPs, are continuously issued and redeemed, trading on national exchanges with the ability to be purchased and sold in the equity trading markets. Target Return ETPs invest directly in flexible exchange options (“FLEX Options”) to meet stated return objectives. These customizable, European-style options contracts may be less liquid than standard listed options, and can only be exercised at maturity. As such, the full value of a Target Return ETP’s upside potential, and/or downside protection, if any, cannot be realized prior to the conclusion of the Outcome Period. Illiquidity of the underlying holdings, whether actual or perceived, may adversely impact the value of the Target Return ETP. Due to the complexity of their structure and underlying holdings, the performance of Target Return ETPs will not always correspond directly to the price performance of the intended underlying market. Additionally, FLEX Options do not entitle investors to the dividends of the underlying security or index from which their performance is derived. Investors should carefully read the product prospectus, which is available through your financial advisor, in order to more fully understand the product’s unique risks, tax consequences, structure, operations, fees, and expenses.
Exchange-Traded Notes (“ETNs”)
An ETN is a common name for a senior, unsecured debt obligation designed to track the total return of an underlying market index or other benchmark, minus investor fees. The repayment of the principal, interest (if any), and any returns at maturity or upon redemption are dependent on that issuer’s ability to pay. Thus, the issuer’s potential to default is an important consideration for ETN investors. ETNs do not generally offer principal protection unless specifically stated in the prospectus. Some ETNs are callable or redeemable by the issuer before their stated maturity date. Furthermore, the trading price of an ETN in the secondary market may be adversely impacted if the issuer’s credit rating is downgraded.
Other Important Information Regarding ETPs
-Non-Traditional ETPs will generally have higher fees than traditional ETPs. All fees and expenses are described in the prospectus.
-The ability of ETP issuers to perpetually create new shares contributes to ETPs efficiently and accurately tracking their respective indices. However, under certain circumstances, issuers may cease or suspend creating new shares, which may cause ETPs to trade at a price that differs significantly from the value of its underlying holdings or index. Furthermore, all ETPs may trade at a premium or discount to its Net Asset Value (NAV) or indicative value in the case of ETNs.
-Some ETPs may have low trading volumes, which could adversely impact your ability to buy or sell shares at the desired price and quantity.
-ETPs can be closed for a variety of reasons, which can cause forced taxable events for investors, including capital gains distributions. Furthermore, there can be closing costs associated with the final liquidation of the ETP as well as index tracking uncertainty as the ETP liquidates its assets.
Investors should consider the investment objectives, risks, and charges and expenses of exchange-traded products carefully before investing. The prospectus contains this and other information about these investments. The prospectus is available from (FA name) and should be read carefully before investing.
SEC Investor Bulletin: Exchange-Traded Funds (ETFs)
SEC Fast Answers: Exchange-Traded Funds
FINRA Non-Traditional ETFs FAQ
FINRA, SEC Warn Retail Investors About Investing in Leveraged or Inverse ETFs