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Exchange traded notes or ETNs are one of the newest financial instruments available for trading and investing. They combine the features of exchange traded funds (ETFs) and mutual funds. They resemble mutual funds in their setup – like mutual funds, they are debt securities which have a maturity date. They resemble ETFs in their trading – like stocks and ETFs, they are traded on centralized exchanges, where one can buy and sell them through a broker.
Like ETFs, ETNs track indexes and their prices differ with regard to the performances of tracking index. But there are some key differences.
- When buying ETNs, you are not buying shares for a portfolio of stock; you are buying only a promise.
- The ETN issuing company makes a promise (as bond) that upon maturity it will payout the cash back to the holder of the notes.
- The cash that the holder receives on maturity is proportional to the performance of tracking index minus any applicable fees.
- Usually there are no dividend or interest payments before maturity.
Exchange traded notes where introduced to the market in June 2006 by the famous Barclays Bank; was named iPath ETNs. From then many notes (just over 50) were issued by many banks which can be grouped to different categories as Commodity, Currency, Strategic and Emerging Market ETNs having different maturity rates.
Benefits of trading and investing exchange traded notes include
1) profiting from market performance,
2) low/no expense ratio compared to ETFs and mutual funds,
3) easy to trade and can be intraday traded,
4) no tracking error,
5) they offer tax benefits
6) they are liquid trading instruments which can be buy long or sell short at any point of time during normal trading hours and
7) offer the opportunity to investors to profit from emerging markets or specific sectors..
Risks of trading exchange traded notes include
1) counter party risk – risk of poor credit rating or bankruptcy of ETN issuing company,
2) they are only promises having no actual security,
3) not much performance history available,
4) involves brokerage fees and commissions, 5) no principal protection,
5) not a best investing option when the stability of financial institutions is in question mark,
6) they are not much liquid as ETFs.
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