ETN – Exchange Traded Note: often referred to as a Structured Note, is a exchange traded debt security, usually issued by an investment bank which generates pre-determined returns based on the performance of an underlying asset; commonly an index, stock, commodity or rate
Many investors are now familiar with ETFs (Exchange Traded Funds) but still lack familiarity with their unpublicized siblings ETNs- one of the triplet of currently exchange traded products. Despite the prevalence of ETFs in investor portfolios ETNs are often left out, despite their intrinsic value as a portfolio diversifier and a cost-effective method of accessing a wide range of securities.
An ETN is issued by a third party financial institution (usually an investment bank) and usually has a maturity date. Some provide returns upon maturity and others pay a coupon interest payment paid intermittently, based on the performance of the underlying assets being tracked. Because of this returns are not guaranteed and if certain conditions are not met you may receive back less of your principal investment than you originally committed. Also, as the ETN is issued by a third-party you will be subject to issuer-risk, i.e. the unlikely event that the bank becomes insolvent and is unable to compensate its investors (this can be negated by choosing large ETN issuers like Goldman Sachs and Commerzbank). It is prudent to remember that you are ALWAYS subject to credit/issuer risk if you have your money in a bank-account. The difference being that in the scenario that you are an investor, you are eligible for returns.
Before You Invest
Make sure you have answers to the following questions so that you can better assess whether an ETN investment is right for you.
Who is the issuer? Once you know, be sure to research the issuer’s credit rating and financial situation. If the issuer is publicly traded, use the SEC’s EDGAR database. Keep in mind that ETNs are not registered investment companies and therefore are not subject to the same registration, disclosure and other regulatory requirements as most ETFs or mutual funds
What index or benchmark does the ETN track? If it involves an unfamiliar market or asset class, ask yourself whether you feel informed enough about the market or asset to effectively assess the risks involved.
Is the ETN callable by the issuer? You can find this out by reading the prospectus or asking your financial professional.
Does the ETN offer leveraged or inverse exposure to the underlying index or benchmark? If so, how frequently does it “reset”? One clue may be in the ETN’s name: words like “daily” and “short-term” often indicate that the product resets daily and is not intended to be held for long periods of time.
What fees and costs are associated with the ETN? ETNs differ widely with respect to fees, including the investor fee charged in connection with redemptions. Read the prospectus and ask your investment professional to clearly explain any fees and expenses associated with a given ETN.
What are the tax consequences? The tax treatment of ETNs can vary depending on the nature of the ETN. Check with your tax advisor if you are unsure about the tax implications of a particular investment.
ETNs are extremely dynamic and customizable for different risk appetites. Starting from the Vanilla, e.g. broad index trackers down to speculative single-stock plays, through to traditionally less correlative underlyings like commodities or currency. We would recommend considering a small allocation to ETNs from credible issuers, based on underlyings that you understand and are comfortable with.