Exchange-Traded Products
It is important to understand how exchange-traded product (“ETP”) fees and expenses affect your investment and return. Of course, you also need to consider the product’s investment objectives, strategies and its risks.
Note: Before buying any ETP, review the product’s prospectus. The prospectus contains important information on fees, charges, risks and investment objectives, and should be considered carefully before investing. You can also review a copy of an exchange-traded fund’s statement of additional information (“SAI”) for additional details.
Summarized below is important information about ETPs including features, pricing, revenue-sharing, expense payments, and fees for data analytics. This summary also explains how E*TRADE from Morgan Stanley (“E*TRADE”) is compensated when you invest in ETPs. Other available investment options feature different fees and expenses, and may provide less compensation to E*TRADE.
You can also visit the websites sponsored by the U.S. Securities and Exchange Commission (www.sec.gov) and the Financial Industry Regulatory Authority (www.finra.org) to obtain additional educational information about ETPs. An ETP’s prospectus and other offering documents (if applicable) contain its investment objectives, risks, charges, expenses and other important information, and should be read and carefully considered before investing.
With respect to fees and expenses, the following information principally pertains to ETP transactions through brokerage accounts on E*TRADE. For more information on fees and expenses in our fee-based advisory account programs, please refer to the applicable Morgan Stanley Form ADV Brochure, and for more information regarding fees and expenses in full-service brokerage accounts, please refer to the disclosure titled “Mutual Fund Features, Share Classes and Compensation” available at www.morganstanley.com/disclosures.
Types of ETPs
ETPs encompass several product types, including but not limited to, exchange-traded funds (“ETFs”), exchange-traded notes (“ETNs”) and commodity trusts, each with distinct features and risks.
Most ETPs are structured as ETFs, which are pooled investment funds that can invest in stocks, bonds and other assets based on each ETF’s specified objective and strategy. ETFs are registered with and regulated by the SEC under the Investment Company Act of 1940 (the “1940 Act”), which includes many investor protections, such as governance and oversight requirements, limitations on leveraged and affiliated transactions, custody and safeguarding of fund assets, and periodic disclosure and reporting obligations.
ETPs can also include ETNs, which are unsecured debt obligations that can provide leveraged or inverse exposure to a variety of underlying benchmarks or reference objects, and separately, commodity trusts, which often seek to invest in or provide exposure to various commodities, including but not limited to natural resources, metals or cryptocurrency.
You should be aware that, unlike ETFs, ETNs and commodity trusts are not registered with and regulated by the SEC under the 1940 Act, which means investors in such products do not avail themselves of 1940 Act protections.
You may also be aware of closed-end funds, which also trade on exchanges and are initially offered to investors through public offerings. Closed-end funds are generally not considered ETPs. For more information on closed-end funds, please see the disclosure titled “Closed-End Funds” available in the E*TRADE Disclosure Library (Closed-End Funds | Disclosure Library).
How ETPs are Managed
Each ETP has its own investment objective and investment strategy, which is described in the ETP’s prospectus. Please note, ETPs may be actively managed or passively managed. In general, actively managed ETPs seek to outperform a market index or target return whereas passively managed ETPs seek to track the performance of a market index or benchmark.
Regardless of whether an ETP is actively managed or passively managed, investing in ETPs involves risk, including the loss of principal. There is no guarantee that an ETP will achieve its objective(s).
Please note that all types of ETPs can utilize complex investment strategies or invest in specialized asset classes, both of which carry significant risks. For more information regarding these assets, investment strategies and risks, such as investing in ETPs with leveraged or inverse strategies or those that seek to provide exposure to cryptocurrencies, please review the ETP’s prospectus, as well as the applicable disclosures available in the E*TRADE Disclosure Library.
Buying and Selling ETPs
When you buy and sell ETPs, those transactions will be executed on the secondary market (i.e., on an exchange), as opposed to transacting directly with the ETP, as is the case with a mutual fund. This means that the price and liquidity of an ETP are directly impacted by the secondary market, and, as a result, ETPs are subject to certain “Market Pricing Risks” described below.
ETF Pricing
As noted, the price of an ETF share is determined by the market, which is different from the value of the ETF’s actual holdings (i.e., the net asset value or “NAV” of the ETF).
Purchasing an ETF at NAV or a “premium” to its NAV (i.e., at a price higher than the value of the ETF’s underlying holdings) and/or selling an ETF at a “discount” to its NAV (i.e., at a price lower than the value of the ETF’s underlying holdings) can significantly affect the realized return earned by an investor. Such realized return can be substantially different from the return of the ETF’s NAV, and, if applicable, the index an ETF may seek to track.
In addition, if an ETF has a lower trading volume (i.e., it is “thinly traded”) or if more market participants want to sell rather than buy an ETF, an investor will likely have to accept a lower price to sell their ETF shares. Investors also purchase ETF shares at the market’s “ask” price and sell at the “bid” price, and bid‑ask spreads increase transaction costs. These risks will likely be pronounced during times of market stress, and any of these situations, among others, could lead to an investor selling their shares at a discount to what the ETF’s underlying holdings are actually worth and/or losing some or all of their principal investment.
An ETF’s investment strategy can also impact the ETF’s ability to provide liquidity to shareholders. For example, ETFs that invest in less liquid or harder to price assets, such as fixed income (particularly high yield, bank loan, or other less liquid credit segments), emerging or frontier markets, small cap equities, commodities, cryptocurrency or alternative strategies such as private equity and private credit, have a higher risk that their shares will trade at a premium or discount to their NAV. Such divergences can be larger, more likely to occur, and/or longer lasting than for ETFs holding highly liquid securities.
Market disruptions, including trading halts or market closures, may also occur and will likely limit your ability to trade ETF shares. As a result, you should consider how these Market Pricing Risks can negatively impact your investment.
Notably, ETFs rely on large institutions to make a market in their shares, which provides liquidity to the trading of the ETF and can help keep the market price of ETF shares closer to the ETF’s NAV than it would be without such “Market-Making Activities.” Market disruptions, new types of ETFs and/or other events, however, can make it challenging for such institutions to continue their Market-Making Activities and there is no guarantee that such activities will continue. As a result, you should not assume that an ETF’s market price will be the same as its NAV.
ETN Pricing
The price of an ETN is also determined by the market rather than the value of the ETN as calculated by its issuer (its “Indicative Value”). As such, ETN investors will be subject to the Market Pricing Risks described above. ETNs, however, typically do not utilize the Market-Making Activities commonly associated with ETFs, which increases the risk that an ETN’s market value will not match its Indicative Value. Additionally, issuers of ETNs can issue and redeem notes at any time, which can adversely affect the ETN’s price in the secondary market.
It is also important to note that ETNs are unsecured debt obligations of their issuers, which are not guaranteed by any third party. As a result, all payments on ETNs, including payments at maturity or upon redemption, depend on the issuer’s ability to satisfy its obligations as they come due. Because ETNs expose investors to the credit risk of the issuer, a deterioration in the issuer’s actual or perceived creditworthiness will likely affect the market value of ETNs. In addition, if the ETN issuer defaults on its obligations, you may not receive any amounts owed to you under the terms of the ETN.
Commodity Trust Pricing
Similar to ETFs and ETNs, the price of a commodity trust is also determined by the market rather than the value of its underlying holdings, which means commodity trusts are likewise subject to Market Pricing Risks.
Some, but not all, commodity trusts rely on large institutions to conduct Market-Making Activities in their shares, which can help keep the market price of a commodity trust closer to that of its NAV (although, as with ETFs, this is not guaranteed). As a result, investors should be aware of how their commodity trust works, as commodity trusts that do not make use of Market-Making Activities are more likely to trade at premiums and/or discounts to their NAVs.
ETP Fees
You should consider the cost of investing in ETPs, particularly if you intend to transact frequently. Please refer to our “Pricing and Rates” page at https://us.etrade.com/what-we-offer/pricing-and-rates to review additional information on pricing, rates and fees. For more information on pricing and/or how ETP fees compare with the costs of transacting in mutual funds, please review the products’ prospectuses.
ETPs generally charge investment management fees and ongoing expenses for operating the product that you will pay while you are invested. These fees and expenses are described in each ETP’s prospectus fee table and vary from product to product. You can use prospectus fee tables to compare the annual ongoing fees and expenses of different ETPs, as well as those of other products, such as mutual funds and closed-end funds.
It is important to understand the above-mentioned fees and expenses because they decrease the return on your investment. As noted, please review an ETP’s prospectus for more information regarding investment costs.
Dividend and Capital Gains Distributions
Domestic ETFs are usually required to distribute dividends and net realized capital gains on their holdings to shareholders. Although ETFs generally experience fewer net realized capital gains than other investment products, such gains can and do occur. Unless an ETF is held in a tax-advantaged account, shareholders will typically have to pay taxes on such income. This is true even if the ETF loses value during a given tax year. Reinvesting these distributions in your ETF does not prevent you from having to pay taxes on the distributions.
On the other hand, ETNs typically do not pay dividends, interest or make distributions, which means that ETN investors are generally not subject to taxable income until they sell their investment or the ETN matures. While certain commodity trusts have similar tax treatments, others generate taxable income annually, even without making distributions.
Please review the prospectus for your ETP, as well as consult with your tax advisor to learn more about its taxation, as E*TRADE does not provide tax advice.
ETP Compensation for E*TRADE
E*TRADE receives the following types of compensation related to ETPs.
Revenue-Sharing
We charge a support fee, also called a revenue-sharing payment to sponsors of actively managed ETPs that can be recommended by Morgan Stanley’s Financial Advisors (“In-Scope ETPs”). We do not charge support fees on any other ETPs available for sale. The support fee is generally applied to client account holdings of In-Scope ETPs based on a tiered rate that increases along with the management fee of the ETP. This means that sponsors pay lower rates on In-Scope ETPs with lower management fees than on those with higher management fees. The rate ranges up to a maximum of 0.12% per year (i.e., $12 per $10,000 of assets).
The tiered rates are the same for brokerage and fee-based advisory client account holdings. However, for advisory accounts there are account type and program exceptions, and the fees are rebated to clients. Please see the applicable Morgan Stanley Form ADV brochure for additional information.
Revenue-sharing payments are generally paid out of sponsor or other affiliate revenues or profits and not from ETP assets. However, sponsor or affiliate revenues or profits may, in part, be derived from fees earned for services provided to and paid for by ETPs. We do not receive any portion of these revenue-sharing payments through brokerage commissions generated by an ETP.
Although we seek to charge the same revenue-sharing fee rate schedule for In-Scope ETPs, we have an incentive to promote the In-Scope ETPs whose sponsors make these payments over other ETPs whose sponsors do not, such as passively-managed ETPs and actively-managed ETPs that are only available on an unsolicited basis. In addition, since our revenue-sharing rates are higher for In-Scope ETPs with higher management fees, this fact presents a conflict of interest for us to promote In-Scope ETPs with higher management fees over those with lower management fees.
Expense Payments and Data Analytics Fees
We provide sponsors of all ETPs with opportunities to sponsor meetings and conferences, and access to our Branch Offices for educational, marketing and other promotional efforts. Representatives for such ETPs may also work closely with us to develop business strategies and support promotional events for clients and prospective clients, and educational activities. Some ETP sponsors or their affiliates reimburse us for certain expenses incurred in connection with these promotional efforts, client seminars and training programs. ETP sponsors independently decide if and what they will spend on these activities, with some ETP sponsors agreeing to make annual dollar amount expense reimbursement commitments of up to $740,000, although actual reimbursements may be higher. Some sponsors of ETPs also invite members of your Morgan Stanley team to attend events. Expense payments may include meeting or conference facility rental fees and hotel, meal and travel charges.
We also provide all ETP sponsors with the opportunity to purchase data analytics regarding ETP sales. For ETP sponsors electing to purchase such data, the fee depends on the level of data and ranges up to $700,000 per year. We also offer sponsors of passively managed ETPs a separate transactional data fee ranging up to $550,000 per year. For an additional fee, all ETP sponsors may purchase supplemental data analytics regarding financial product sales at our Firm.
These facts present a conflict of interest for us to the extent they lead us to focus on ETPs from those sponsors that commit significant financial and staffing resources to promotional and educational activities and/or purchase data analytics instead of ETPs from sponsors that do not.
ETP representatives are allowed to provide funding for client/prospect seminars, employee education and training events, and an occasional meal and entertainment and gifts. Our non-cash compensation policies set conditions for these types of benefits, and do not permit any funding conditioned on achieving any sales target or awarded on the basis of a sales contest.
Other Compensation Received from ETPs
We or our affiliates receive, from certain ETPs and/or their sponsors, compensation in the form of commissions and other fees for providing traditional brokerage services, including related research and advisory support, and for purchases and sales of securities for ETP portfolios. We also receive other compensation from certain ETPs for financial services performed for the benefit of such ETPs. We prohibit linking the determination of any compensation from and service fees charged to an ETP to the aggregate values of our overall ETP-share sales, client holdings of the ETP or to offset the revenue-sharing, expense reimbursement and data analytics fees described above.
Availability of Affiliated ETPs
Certain of our affiliates, which include Morgan Stanley Investment Management, Eaton Vance, Boston Management and Research, Calvert Research and Management, Atlanta Capital Management Company and Parametric Portfolio Associates, serve as the investment adviser to certain ETPs that we offer (“Affiliated ETPs”). These affiliated entities receive investment management fees and other fees from the Affiliated ETPs. Therefore, we have a conflict of interest to promote Affiliated ETPs. Affiliated ETP sponsors are subject to the same economic arrangements with Morgan Stanley as described herein.
For More Information
For additional information on a particular ETP’s payment and compensation practices, please refer to the ETP’s prospectus and, if applicable, statement of additional information. If you would like more information on how ETFs compare with mutual funds, as well as certain factors that impact ETF liquidity, please see the disclosure titled “Considerations Involving Mutual Funds, Exchange-Traded Funds and Money Market Funds”, which is available in the Disclosure Library.
Morgan Stanley Smith Barney LLC, its affiliates, and its Financial Advisors do not provide tax advice. Clients should speak with their own tax advisors regarding their personal situation. The information contained herein has been obtained from sources that we believe are reliable, but we do not guarantee its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation by us for the purchase or sale of any security. This material, or any portion thereof, may not be reproduced without prior written permission from Morgan Stanley.