Or as FT Alphaville states the issue:

So when is an ETF not an ETF? When it’s an ETP or structured product.

The debate around the distinction between ETFs (exchange traded funds) and other traded exchange traded products (ETPs) continues on.  It is a valuable debate, because there are real distinctions between ETFs, ETNs and funds that utilize futures of swaps to create a return stream.  To-date, the difference to investors is largely theoretical.

Leaving aside the issue of actively managed ETFs, the ETF structure is quite simple.  The fund holds all of the underlying securities in an index.  The issue gets somewhat muddled where the manager needs to sample the underlying universe of securities or is limited in their holdings.  The latter being the case in some international equity ETFs.  In both cases, tracking error can result.

The problem is that to the end user (or investor) ETFs, ETPs and ETNs all work in the same fashion and are traded in the same way.  To the end user a plain vanilla S&P 500 ETF, a 3x leveraged S&P fund or a covered call version of the S&P 500 in ETN form all trade in the same way although they have very different return profiles.  This is where problems can arise.

Many investors and advisors never made much distinction between ETFs and ETNs.  When ETNs launched there were some perceived benefits to the structure.  Indeed one can think of some specific examples where the underlying asset class and tax benefits could be best utilized in an ETN-type structure.  Upon launch analysts noted ETNs had credit risk.  ETNs are obligations of the issuer, like a bond.  This risk was perceived as remote and theoretical at best.  It was not until the failure of Bear Stearns and Lehman did the risk of the ETN structure really become evident to all.

The same could be said for what is happening now with various ETPs that use future and swaps to generate returns.  In the case of the United States Natural Gas Fund (UNG) there are real issues with the size of the fund and its effect on the natural gas futures market.  When this fund, and others, were launched this issue was thought to be a remote possibility.  Now that is a reality, this debate become more heated.

We all can easily call these funds by more appropriate names.  The question is whether this will really help all that much.  We would agree with Matt Hougan at IndexUniverse.com who writes:

The issues we are dealing with do not revolve around word choice. They revolve around whether or not investors understand the products they’re allowed to buy.

So until either the government or industry make these distinctions clearer to investors, through enhanced disclosure or investor qualifications the issue remains the same.  Traders can trade these products to their heart’s content ignorant of the differences.  Until that changes, it is more important than ever that you know what YOU own.