Exchange-Traded Notes: Know Before You Invest
An exchange-traded note, frequently referred to as an ETN, is an unsecured debt obligation of an issuer, typically a financial institution. Unlike a traditional corporate bond that pays a stated rate of interest, the return on an ETN is based upon the performance of a specified index or benchmark such as a broad-based securities index, or an index tied to anything from commodities to foreign currencies to emerging markets or other things. ETNs trade on a securities exchange and promise to pay an amount based on the performance of the underlying index or benchmark on the ETNs’ maturity date, minus any investor fees. ETNs are sometimes confused with exchange-traded funds (ETFs). ETFs and ETNs are both traded on a securities exchange, but unlike ETFs, ETNs do not buy or hold assets. Because ETNs do not own an underlying portfolio of assets, holders of ETNs are subject to the creditworthiness of the issuer.
ETNs may be bought and sold at market prices. The prospectus for the ETN should disclose how the value of the ETN is determined on any particular trading day and how the value of the index the note tracks is calculated. At the end of each trading day, the issuer will publish the amount an issuer would be obligated to pay the investor (published value). Market values, however, may vary from the published values for several reasons. The most typical cause of price variance is when the issuer suspends the issuance of new ETNs. If the ETN is trading at a significant premium to its published value, you may wish to consider a similar product that is not trading at a premium.
Things to consider and discuss with a financial professional before investing in any ETN:
Complexity – ETNs are complex products. Make sure you understand who the issuer is (including its credit rating and financial condition); what index or benchmark the note tracks; if the note is callable, and if so, when; the fees and costs associated with the purchase and redemption; the potential tax implications of the investment; and whether the note is leveraged or offers inverse exposure to the underlying index.
Price Volatility – ETNs can lose money. ETNs can trade at premiums or discounts to their market value.
Leveraged or Inverse ETNs – ETNs that are leveraged promise to pay a multiple of the performance of the index it tracks. An ETN that is said to have 2x leverage, for example, will pay twice the performance of its underlying index. An inverse ETN pays the inverse, or opposite, of the underlying index. Many leveraged and inverse ETNs are designed to achieve their stated performance objectives on a daily basis. As such, they are generally meant to be used as short-term investments, rather than buy-and-hold investments.
Credit risk – ETNs are unsecured debt obligations of the issuer. If the issuer defaults on the note, you may lose some or all of your investment.
Market risk – The value of the ETN will change as the value of the index it tracks changes.
Liquidity risk – a ready market doesn’t always exist for ETNs. If you need to liquidate your investment, you may not been able to sell your ETN immediately and/or you may not be able to sell your investment at a price that you consider reasonable.
As with any investment, before you invest, you should learn as much as possible about the potential investment and consider how the product fits with your risk tolerance and overall investment objectives.