ETFs vs Structured Products. What are the differences?
Anto Joseph on 08 May 2021
EXCHANGE TRADED FUNDS (ETF) are a basket of securities that trade on an exchange, like a stock. ETFs provide investors with broad market exposure.
STRUCTURED PRODUCTS are pre-packaged investment strategies that have been created with a specific and targeted investment objective. Structured products provide investors with tailored exposure and clarity of risk and return.
ETFs and Structured Products are both useful investment tools for assembling impactful portfolios. But they support an investment portfolio in different ways. Therefore it's important to understand the main differences between them as investment solutions. So what are the main differences?
What is an ETF?
ETF stands for Exchange Traded Fund. An ETF is an investment fund that you can buy and sell on an exchange just like a listed security e.g. CBA shares. The price of an ETF can fluctuate throughout the trading day in the same way that shares do. However, unlike investing in the stock of a single company, ETFs combine different securities into a single tradable product that can be made up of shares, bonds, derivatives and commodities. The ETF creator arranges the underlying securities to create the product and generally buys all of the required securities and holds them as fund-linked assets. They then register the newly created ETF and its securities, arrange for it to be listed on an exchange and then sell the securities in that fund to investors as ETF units. By purchasing the securities in the ETF, investors will own a portion of the ETF.
ETFs have become a popular way for investors to achieve relatively cheap and easy portfolio diversification within a selected investment strategy. Instead of owning the shares in a handful of listed companies, investors can have exposure to the performance of a range of companies by simply owning the securities of an ETF. Depending on the type, ETFs have varying levels of risk.
What is a Structured Product?
A Structured Product, is a pre-packaged investment that has been assembled to deliver on a defined investment objective over a specified term. Structured products are typically not listed on exchanges and have traditionally been difficult to source and access because of their exclusivity; they are traded over-the-counter (OTC), typically by investment banks.
Structured products consist of one or more underlying assets and at least one derivative. Similar to ETFs, structured products offer exposure to a variety of different underlying assets such as a commodity like gold or a basket of stocks. The derivative component of the structured product, usually an Option or a Future, is what helps determine the overall risk and return on the structured product. It is because of the Option or Future overlay that an investor is able to effectively achieve a targeted return on an investment for the specified level of ‘clearly defined’ risk being taken.
Structured products are packaged by investment banks, which means they use ‘best of class’ institutional strategies. It also means that the assembly, formation and issuement of structured products can be completed quickly, almost as soon as the idea (or investment thesis) is confirmed. As a result, structured products are able to be deployed quickly into the market, enabling them to take advantage of market trends and investor expectations. Most importantly, to capitalise on the investment thesis within established time based parameters. As structured products are able to be structured to support different investment objectives, they provide the ability to cater for diverse risk profiles. They are a popular choice for investors who want to benefit from a particular view of the market over a defined period, or investment term, whilst accessing features such as capital protection, income accumulation, income streaming or leverage. Their flexibility to meet specific needs of investors makes them an effective instrument for targeted investment.
What are the similarities between ETFs and Structured Products?
Although they are fundamentally different tools which investors can utilise, there are some operating similarities between the two.
Diverse exposure. Both ETFs and Structured Products can give diverse exposure across different asset classes. This enables investors to achieve broader portfolio investment diversification in a simple and cost-effective way.
Target investment objectives. Both ETFs and Structured Products can cater to specific investment objectives. From, growth, to income to small-cap stocks to emerging markets and commodities, even impact and green investment focus. Investors can target almost every investment strategy to create an optimal portfolio for their objectives and priorities.
SMSF & Discretionary Trust eligibility. Both ETFs and Structured Products are eligible to be invested into by Self-Managed Super Funds and Trusts. They are growing in popularity amongst Trustees because they provide an easy, transparent and compliant means of achieving portfolio diversification and the ability to access non-traditional asset classes with diverse risk profiles.
Convenience. Both ETFs and Structured Products potentially save an investor a substantial amount of time in due diligence and asset selection. For example, investors seeking to benefit from portfolio exposure to a specific market trend - such as President Biden’s $2.25 Trillion dollar stimulation clean energy plan - would need to undertake an extensive amount of time consuming research in order to ascertain which companies are likely to directly benefit from this trend. Thematic ETFs and structured products are brought to market by the issuers with the heavy lifting research and analysis having already been completed for the investor, and assembled with the right combination of underlying assets to best capture the theme that optimises the risk/return pay-off.
What are the differences between ETFs and Structured Products?
Asset exposure. Both ETFs and Structured Products offer exposure to a variety of assets classes. However, structured products tend to offer greater versatility because of the ability to use global institutional investment capabilities. This gives investors more choice and flexibility to diversify their portfolio and pursue specific investment strategies.
Capital preservation. One of the key features and benefits of structured products is that they can be embedded with some level of downside protection. This is done through the use of institutional derivatives. Their use will determine the overall risk of a product whilst simultaneously ensuring that the specific needs of an investor are met. For example, depending on investor objectives, a downside barrier may be specified on a basket of listed company securities to provide a form of protection from market volatility.
Aggressive Exposure. For investors wanting enhanced returns, there are structured products available that put more of the invested capital at risk. Through the use of institutional options in a targeted and customised way, investors can ensure their risk-return ratio is tailored to their portfolio requirements.
Be it capital preservation or growth objectives, structured products can be designed to suit various market conditions such as bullish, bearish or flat.
Time-Frame Bound. Unlike most ETFs which are open-ended investment products and continue to remain in circulation until the issuer (sponsor) makes the decision to withdraw them, each Structured Product is launched as a vintage or series which includes a specified investment term. The term is often dictated by the maturity on the Options or Futures that wrap the underlying assets, which are also responsible for pay-off and the pricing. As a result of being time-frame bound, the investor benefits from the certainty of knowing the maximum term they will be in the investment. This of itself ensures that portfolios don't become out-dated, stale and unresponsive because as the investments mature, investors are being kept alert to their re-investment strategy as defined by their investment objectives and changing risk profile.
Access to emerging market trends. Investors who have identified an emerging market trend and wish to invest into the market opportunity are able to do so through thematic based investing. Put simply, thematic investing offers investors a systematic way to gain exposure to emerging technologies, macro-economic developments or global socio-economic trends that will, in theory, deliver the investment returns being sought. Both ETFs and structured products offer thematic investing.
However, thematic ETFs can be more generic, loosely targeting the trend and lacking specificity. Furthermore, by the time the thematic ETF hits the market, the trend may have already played out.
In comparison, thematic structured products provide specificity and speed to market due to their OTC nature, and their ability to trade indices that are not listed on exchanges. If there is an unlisted index that provides a certain thematic exposure, an ETF investor may struggle to access an ETF that provides the same desired exposure.
Life time of investment. ETFs can be traded daily. There are no restrictions on how often you can buy and sell them. This makes ETFs suitable for investors who plan to trade more actively, rather than buying and holding for the long term.
Structured products, on the contrary, are typically closed ended products that come with a pre-defined maturity date. The investment period can range from 6 months to 5 years depending on the product. This makes it easy for investors who want to align their investment to a particular objective. In most cases, it is possible for investors to exit a structured product before the maturity date, but they may not reap the full financial benefit of the product.
Fees. Structured products are targeted investments, assembled by globally diverse investment teams which provide clarity of risk and return, and therefore typically have higher fees than ETFs. ETFs aim to track the performance of an index or asset class or rules-based methodology, therefore investors tend to benefit from lower management fees.
Speed to market. A key difference between ETFs and structured products is the time it takes to bring a new product to the market. Because ETFs are listed it takes significantly more time to launch than a structured product. This leads to vast differences in the capturing of new market trends, linked opportunities and possibly investment outcomes. When a new trend arises, a structured product can capitalise on it quickly whilst an ETF takes longer to launch which may have an investment timing impact.
Summary
While ETFs offer a convenience unmatched in the public trading markets, structured products offer unmatched flexibility and specificity, allowing investors to achieve targeted access to almost any asset with almost any pay-off structure. Generally, ETFs provide investors with broad market exposure, and structured products provide investors with a tailored specific exposure. Historically, the biggest hurdle for structured products has been the ability for investors to access them with convenience and ease. However, with platforms like Stropro, it is now possible for investors to seamlessly access structured products and the powerful benefits they bring to investor portfolios. Our partnerships with global investment banks affords clients on the platform exclusive access. Stropro regularly offers structured products based on an investment thesis curated by our team of researchers.
Anto is the founder and CEO at Stropro. This article is for educational purposes and is not a substitute for professional and tailored financial advice. This article expresses the views of the authors at a point in time, which may change in the future with no obligation on Stropro or the author to publicly update these views.
Investment opportunities on Stropro are available to wholesale sophisticated and professional investors. To find out if you are eligible, register on the Stropro platform and see what each of these investor types mean and help you self assess. Get started at https://portal.stropro.com/Signup/
Sources:
https://www.etf.com/etf-education-center/etf-basics/why-are-etfs-so-cheap
https://www.etf.com/sections/features-and-news/how-launch-your-etf?nopaging=1
This article has been prepared by Anto Joesph. Anto is the CEO at Stropro Operations Pty Ltd (ABN 28 633 603 399) (Stropro). This article is for educational purposes and is not a substitute for professional and tailored financial advice. This article expresses the views of the author(s) at a point in time, which may change in the future with no obligation on Stropro or the author to publicly update these views. This article uses information from sources the author considers to be reliable but does not represent that such information is accurate or complete, or that it should be relied upon. Past performance is not a reliable indicator of future performance. Investments may rise and fall in value and returns cannot be guaranteed. Stropro makes no representations or warranties, express or implied, are made as to the accuracy or completeness of the information it provides. Stropro is a Corporate Authorised Representative (CAR No. 1277236) of Lanterne Fund Services Pty Ltd (AFSL No. 238198).
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