ETC vs. ETF: An Overview
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.
- An exchange traded commodity (ETC) is often described as a commodity-focused exchange traded fund (ETF), however, that is not the entire story.
- An ETC is also a specific type of security traded on an exchange that tracks a commodity or a benchmark but whose assets are a debenture issued by a bank.
- In contrast to ETFs, which typically contain a basket of commodities or other securities, an ETC allows for exposure to one single commodity.
- The benefit of an ETC is that it allows investors exposure to commodities without having to trade in futures and options, which are more complicated instruments.
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. In this sense, ETCs have a share price that moves up and down as the price of the underlying commodities fluctuates in value.
ETCs make it easier for individual investors to gain access to specific commodities that may typically be difficult to gain access to, particularly without investing in futures or options, which are more complicated products. While ETFs are generally a basket of stocks or commodities, an ETC allows for exposure to one single commodity.
The performance of an ETC is linked to either one of two factors: the spot commodity price or the futures price. The spot commodity price is the current price for delivery whereas the futures price is for delivery at a future date.
ETCs are investment funds that are managed by an investment manager and charge an expense ratio to cover the costs of management.
ETF (or ETN)
Commodity ETFs invest in a commodity; either by buying or selling the underlying commodity the ETF is meant to track, or buying or selling futures contracts on the underlying commodity. 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 be able to financially back the ETN. This would make the ETN worthless, even though the underlying commodity still has value.
The benefits of investing in commodities include acting as an inflation hedge and having a low correlation to equities and bonds.
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.
Consider 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 iShares Physical Gold ETC (SGLN), investors don't own a 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.
While the first fund, IAU, has a 0.25% expense ratio, SGLN has a 0.12% expense ratio. Still, both 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, against the benchmark.
|iShares Physical Gold ETC (SGLN)||-3.89%||23.95%||18.53%|
|iShares Gold Trust (IAU)||-3.99%||23.83%||18.57%|
|LBMA Gold Price (Benchmark)||-3.75%||24.17%||18.83%|
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 be hard to enter and exit positions (especially large ones) at efficient prices, and that could have a negative impact on personal returns.
Are Commodity ETFs Worth It?
Yes, commodity ETFs can be a good investment and a great way for an investor to diversify their portfolio. There are a variety of commodity ETFs that can suit an investor's investment goals and risk tolerance. Like any investment, an investor should research the potential investment to determine if it is a right fit for them.
What Is the Largest Commodity ETF?
The largest commodity ETF is SPDR Gold Trust (GLD). As of March 15, 2022, it manages $66.8 billion. The fund holds physical gold and allows investors exposure to gold without having the need to hold physical gold themselves.
What Is the Most Diversified Commodity ETF?
One of the most diversified commodity ETFs is the Invesco DB Commodity Index Tracking Fund (DB). The fund trades in 14 of the most heavily traded and important commodities in the world, according to its prospectus. The commodities traded are NY Harbor ULSD, brent crude, gasoline, WTI crude, gold, wheat, aluminum, corn, soybeans, natural gas, zinc, copper, sugar, and silver.
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.