While many regular readers of personal finance blogs are aware of ETFs (Exchange Traded Funds), there is a cousin to the ETF known as an ETN, or Exchange Traded Note. While they look and feel on the surface just like an ETF and are traded like ETFs on an exchange, ETNs differ in a few key ways to ETFs:
- An ETN does not hold direct investments in the underlying assets that it tracks, whereas an ETF does
- An ETN is actually an unsecured debt obligation of the issuer, which has a maturity date, usually set to 30 years – if you hold the ETN until maturity, it will mature and you will receive cash, but I suspect most investors will buy and sell them just like ETFs
- While structured as a senior debt note, the return is linked to the performance of a stated index or benchmark – basically, it is an IOU from the issuer to provide the performance of a designated security or index
- They do not pay interest or dividends
- ETNs have credit risk of the issuer unlike an ETF. If an ETF provider went under, you still own the underlying securities in the ETF portfolio. If an ETN provider went under, you may be out of luck.
- ETNs have no tracking error since the notes don’t actually buy the linked assets
- There is the potential that the IRS may elect to treat gains from ETNs as interest income due to the debt note structure (this is still up in the air)
- MERs are normally around 0.75% (some currency pair tracking ETNs are 0.40%, and of course as new products are launched these figures are subject to change)
- ETNs are currently used for commodity type investments, emerging market exposure and alternative investment class tracking – they were designed to ease the access to special asset classes and investment categories
Given the current state of affairs in global financial institution credit worthiness, notwithstanding the ambiguity of the future tax treatment and higher fees for accessing ‘exotic’ assets, you should really consider the disadvantages of using ETNs in your portfolio before making any decisions to purchase them. Remember to consult with your own qualified financial advisor first.
Barclay’s has about $5 Billion in ETNs on the market, you may know them as the iPath product (the ETFs are iShares).