ETC vs. ETF: What's the Difference?

ETC vs. ETF: An Overview

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, where the London Stock 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.

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. 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.

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.

Difference Between ETF and ETC

Let's summarize some of the key differences between the two. The main differences between an ETF and an ETC are:

• Underlying Assets: ETFs can hold a variety of assets such as stocks, bonds, or a combination of different asset classes. ETCs specifically track the performance of commodities such as precious metals (gold, silver), energy resources, or agricultural products.
• Structure: ETFs are investment funds that are traded on stock exchanges. They usually represent a diversified portfolio of assets. ETCs are also traded on stock exchanges, but they are specifically designed to provide exposure to the price movements of a particular commodity. In some ways, investors can see ETCs as less diversified.
• Management: ETFs can be passively managed or actively managed. ETCs are often passively managed.
• Liquidity and Trading: ETFs are generally highly liquid. In many cases, ETFs trade many shares throughout the entire day. ETCs, being commodity-focused, may have liquidity influenced by the specific commodity market they are tracking. In this case, they may have less liquidity compared to more common ETFs.

Real-World Examples

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.

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. 

The Bottom Line

The differences between an ETC, an ETF, and an ETN are complex and filled with legal jargon. 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.