ETCs

What are they and how do they work?

ETCs are securities with no specified maturity date, issued by a vehicle company against the issuer’s direct investment in either commodities or commodity-based derivatives contracts.

The price of ETCs is therefore directly or indirectly tied to the trend in the underlying, in exactly the same way as the price of ETFs is tied to the value of the reference index.

Briefly, an ETC offers the possibility to:

• Gain direct access to the commodities market: ETCs replicate the performance of a single commodity or of commodity indices, due to the issuer’s direct investment in the commodity or in commodity-based derivatives contracts.  In the latter case the ETCs allow investors to have an exposure similar to what would be obtained by managing a long position in futures contracts without financial leverage.
• Remain constantly aligned with commodity performances: unlike a position in futures, ETCs do not imply the need to roll over positions from one future contract to another, do not require any margin, and do not entail other charges for brokerage/replacement of expiring contracts.
• Furthermore, the ETCs, which invest directly in the commodities, make it possible to avoid the charges and risks associated with their storage.
• Obtain exposure to a total return.  In the case of ETCs linked to the price of future contracts on the commodity, the investor has access to a total return comprising three different elements:

              - spot return: this is the return deriving from fluctuations in the price of the underlying commodity future;
              - roll return (which can be either positive or negative): this is the return associated with the activity of replacing the expiring future contracts in order to maintain the position on the underlying; the roll return is negative (contango) when the expiring contract has a higher price that the subsequent one and positive (backwardation) in the opposite case.
              - collateral return: this is the interest earned on the investment of the collateral (the purchasing of futures does not in fact require any investment other than to maintain a margin which, however, is also remunerated).

• Gain access to the commodities market at a very low cost: as with ETFs, investors are not charged any “entrance”, “exit” or “performance” fee, management fees are low and are applied pro-rata according to the length of time the security is held, by reducing the quantity of commodity entitlement.
  
  

Finally, as with the purchase of any other security on the market, consideration should be given to the charges applied by the investor’s bank/brokerage company.

A characteristic common to ETFs and ETCs is the existence of a primary and secondary market for each class of security.

The primary market, accessible only to authorised intermediaries, provides the possibility to subscribe and redeem securities on a daily basis at the official reference market price of the underlying commodity (some ETCs also provide for the possibility to carry out the subscription in kind, namely by directly delivering the commodity to the issuer).

The secondary market is represented by the Stock Exchange, where all investors can trade the ETCs at the price determined by the best bids and offers present on the trading book.  This mechanism allows specialised intermediaries to carry out arbitrage transactions which ensure that the price of the ETCs is always constantly aligned with the market value of the underlying commodity as happens in the case of ETFs.