In everyday conversation, an exchange-traded commodity (ETC) could refer to a commodity exchange-traded fund (ETF), but an ETC is actually a product name for a specific type of security. The term ETC is commonly used in Europe and Australia, where the London Stock Exchange and Australian Securities Exchange provide trading products called ETCs. Most investors won't notice a difference between most commodity ETFs (or commodity exchange-traded notes (ETNs) and ETCs, but there are structural differences.
What is an ETC?
An ETC is traded on a stock exchange, like a stock, but tracks the price of a commodity or a commodity index. This allows investors to gain exposure to commodity markets without buying futures contracts or the physical commodity. ETCs have a share price that moves up and down as the price of the underlying commodity(ies) fluctuate in value.
Differences Between an ETC and ETF (or ETN)
Commodity ETFs invest in a commodity—either by buying/selling the underlying commodity the ETF is meant to track, or buying/selling futures contracts on the underlying commodity, while an ETC doesn't do this directly. An ETC is a note, or debt instrument, which is underwritten by a bank for the issuer of the ETC. An ETN has this same "note" structure. Therefore, it has a risk that the underwriter could default, and thus not able to financially back the ETN, making it worthless, even though the underlying commodity still has value.
An ETC is a fusion between an ETF and ETN. It is backed by an underwritten note, but that note is collateralized by physical commodities, purchased using the cash from capital inflows into the ETC. This reduces the risk of underwriter default issues.
Like an ETN, an ETC has very few tracking errors, since the note tracks an index and not the physical futures contracts or physical commodities it holds. An ETF tracks its holdings, which makes it susceptible to tracking errors, where the movements of the commodity price are not accurately reflected in the price movements of the ETF over time.
Examples of the Differences Between an ETC and ETF or ETN
Consider BlackRock's iShares Gold Trust (IAU). A trust is a type of ETF that buys physical gold in exchange for shares issued. The buyer of the ETF, therefore, owns a fractional piece of the gold held in trust.
In the case of BlackRock's iShares Physical Gold ETC (LSE: SGLN), investors don't own piece of the gold they are investing in. Rather, the underwriters of the fund financially back the note (the ETC) with the holdings. The structures are similar, but not the same.
Both funds mentioned above have a 0.25% expense ratio and very efficiently track the price movements of the London Bullion Market Association (LBMA) gold price, which the investment vehicles are meant to track. The yearly returns below show there are minimal performance differences between the two.
|iShares Physical Gold ETC (SGLN)||-11.65||8.85||11.58|
|iShares Gold Trust (IAU)||-11.71||8.88||11.56|
|LBMA Gold Price (Benchmark)||-11.42||9.12||11.85|
Often there are only minor differences between the performance of an ETF, ETN and ETC, but in certain circumstances, performance can vary greatly. Before investing or trading in any product, search out comparable ETFs, ETNs and ETCs. There may be one that consistently performs better than its peers, or that has a lower expense ratio (which helps boost returns).
The performance and the structure of an investment vehicle aren't the only considerations when choosing whether to invest in an ETF, ETN or ETC. Other factors, such as volume, should also be considered. While a fund may track its index very closely in theory, if the investment vehicle has little volume it will may be hard to enter and exit positions (especially large ones) at efficient prices, and that could have a negative impact on personal returns.
The Bottom Line
The differences between an ETC, an ETF and an ETN are complex and filled with legal jargon. Prospectuses for these types of products are typically long, but should be read, so all risks are known before investing. One product is not necessarily better than another; rather investors should compare any investment opportunity to similar-type investments before choosing the best one for them.
In terms of structural differences between an ETF and an ETC, the ETF invests directly in physical commodities or futures contracts. An ETC is a debt note, backed by an underwriter, which then collateralizes the note with buying the commodity. Investors will often find little difference between the various types of exchange-traded products, but a bit of research before investing may reveal one product does have a slight advantage over another.