All About ETNs
Exchange Traded Notes are the latest financial product to hit the street, and they are quite different from Exchanges Traded Funds. They may have a similar name, but ETNs are more risky than ETFs.
An ETN is basically an unsecured promissory obligation, which is issued with the backing of a financial institution. They are really like bonds, but instead of giving someone a fixed rate of interest, or a coupon, they guarantee a return that is linked to an index. So it’s like an index tracker, with no tracking error, but with the risk that the financial institution issuing the ETN will not honor it. So now investors can choose between credit risk and tracking error. Of course a tracking error is a small loss, but credit risk can wipe you out completely. The Lehman shock is still fresh in investors minds.
Just like an Exchange Traded Fund, an Exchange Traded Note can be bought and sold during the day. An Exchange Traded Note has a fixed maturity date. Since companies can issue ETNs based on any index they offer access to a broader range of markets than ETFs.
You will see that Exchange Traded Notes trade at premiums and discounts to their indicative Net Asset Value, or NAV. When you come across one of these products that is trading way below its NAV then you can take it as a sign that the market believes there is a credit risk. However, with that said, the ETNs that were issued by Lehman Brothers didn’t trade at a discount at all. Then they went belly up.
The unique structure of the ETN allows providers to replicate a wide range of asset-allocation strategies across commodities, foreign markets, and currencies. This means that individual investors can enjoy the benefits of accessing markets that before the advent of ETNs were only open to rich clients.
When you invest in Exchange Traded Funds it is important to remember that you have no claims on the underlying assets of the investment, and that ETNs are regulated by the Securities Act of 1933, not by the Investment Company Act of 1940 which controls ETFs.
Holding ETNs for more means that any profit will be treated as long term capital gains, but if you sell them in under a year then any gains will be taxed as ordinary income.
If you are interested in what an ETF Analyst has to say about ETFs, ETNs and other ETF instruments then : http://hubpages.com/hub/ETF-Analyst-Leveraged-ETFs-are-Toxic
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