Are Exchange-Traded Notes Too Risky for “Retail Investors?”
April 20, 2012
Two popular exchanged-traded notes (ETN) recently made headlines news as they saw half of their value evaporate in a matter of days. These disastrous drops cost investors hundreds of thousands of dollars and has experts (including FINRA regulators) wondering if these volatile investment options are too risky for retail investors.
In a nutshell, an ETN is an unsecured debt security note created by a bank or some other financial institution. They’ve become popular with financial institutions (especially those in Europe) because they are an easy way to raise quick cash. For the investor, an ETN is little more than a gamble on the issuing institution’s debt.
And to the casual observer, the tables are hot. ETNs have rapidly increased in both popularity and volume. In just six years since they first debuted, ETNs have carved out a substantial market share. There are currently 212 ETNs available representing roughly 15% of all exchange-traded products.
To many retail investors, ETNs seem like a good way to gain access to segments of the market (gold, silver, natural gas) that are trendy and have the potential for huge profits. But retail investors are unlikely to understand the massive risk associated with ETNs, including the potential for losses and the high-stakes gamble on the issuing institution.
Two Cautionary Tales
VelocityShares Daily 2x VIX Short-term ETN (TVIX for short), managed by Credit Suisse, was one of the most-sought after ETNs on the market. Now it’s under investigation by FINRA officials for perceived deficiencies in financial controls.
Why? Because TVIX lost 29% of its value in one day of trading. That tremendous loss came on the heels of a month-long series of losses that saw the valuation of the TVIX ETN drop from $17.01 to just $14.43. When the smoke cleared, TVIX had racked up a net loss of over 60% of its value in less than one month.
The loss was so shocking that FINRA and Massachusetts state officials are investigating TVIX. Secretary of the Commonwealth William Gavin announced that his office would be opening official inquiries into the inner workings of TVIX and stated that a pointed letter had been sent to Credit Suisse officers asking a number of uncomfortable questions.
But TVIX and Credit Suisse are not alone. More recently, the iPath Dow Jones-UBS Natural Gas Total Return Sub-Index ETN (an ETN which trades on natural gas futures) took a nose dive. The ETN, issued by Barclays Capital, lost 22% in just one week. That loss is hot on the heels of a 24% drop the week before.
What’s Wrong With ETNs (And What is FINRA Doing to Fix Them?)
Many financial analysts argue that many ETNs are “structurally flawed.” Some even claim that the very name of the products themselves is misleading. “Exchange-Traded Note” sounds very similar to “Exchange-Traded Funds,” which are a more well-known category of exchange-traded securities similar to mutual funds. ETNs and ETFs share little in common, but the nomenclature can be confusing to retail investors.
Although FINRA has stepped in to investigate the spectacular decline of TVIX, no one knows how far their investigation will go. Some say that FINRA should either ban ETNs (either temporarily or even permanently) or require them to carry some sort of warning label.
In fact, even the financial institutions involved with ETNs are considering taking action. For example, BlackRock, Inc., the largest manager of ETNs in the world, has recommended that both regulators and legislators create rules to prevent investment firms from selling ETNs to unsuspecting investors.
Have You Suffered Unexpected Losses from Purchasing ETNs?
With FINRA opening investigations into the mechanics of all ETNs (not just those which have performed so poorly recently), victims of unscrupulous investment firms or individual salespeople may have some financial recourse. If improprieties are discovered, an investment fraud lawsuit could allow you to recoup some, if not all of your losses.
If you would like to learn more about ongoing ETN investigations or to speak with a qualified securities fraud lawyer for a free and confidential consultation, you may contact us by calling toll-free (866) 981-4800 or filling out the form to your right.