What are Exchange Traded Notes?
Exchange traded notes, popularly known as “ETNs,” are traded notes which allow investors to place bets on the performance of an index while subject to the credit risk of the ETN issuer. Instead of owning a piece of the index, investors purchase a bond from a bank or financial institution that is tied to any number of financial instruments, including emerging markets, commodities such as gold and oil, foreign currencies and even market volatility.
ETNs do not pay interest but instead pays a “distribution” determined by the performance of the index at the ETN’s maturity date. Most ETNs mature within 10 years of issuance, but in some instances maturity is as far as 40 years away. ETNs trade throughout the day at market price, similar to stocks or ETFs, but do not buy or hold assets.
Return on an ETN depends largely on price changes in the value of the ETNs index if it is sold prior to maturity or on the value of the distribution at maturity.
SEC Warnings Concerning ETNs
ETN investing comes with its own set of risk and the SEC has issued several warnings about the dangers of ETN trading for uninitiated or amateur investors. These risks include:
- Credit Risk – Because ETNs are unsecured, if the issuer defaults the investor will likely lose the entirety of their investment.
- Market Risk – ETNs trade on the market daily and thus are subject to market trends. As the value of the index tracked by the ETN fluctuates, so too will the value of the ETN.
- Liquidity Risk – Various market situations may cause the desirability of the ETN or the index it tracks to evaporate. If this occurs, investors will have a tough time unloading their ETNs.
- Price-Tracking Risk – ETNs are popular with high-volume traders and hedge funds. As such, there may be issues with tracking the minute-by-minute value of the ETN, including the potential to buy or sell at a loss.
- Holding-Period Risk – Many ETNs come with holding periods as short as one day. Long-term investment may lead to astronomical compounding of the ETN’s multiplier, which could lead to substantial losses.
- Call and Acceleration Risk – ETNs may also be subject to early redemption or an “accelerated” maturity date because they are issued at the discretion of the financial institution behind the ETN. An unlucky investor might find her ETN called at a price below what she paid for it.
- Conflicts of Interest – ETNs issuers may engage in trading activities that are at odds with optimal performance of the ETN.
Leveraged and Inverse ETNs
Two popular subsets of ETN are the leveraged and inverse ETN.
Leveraged ETNS offer “leveraged” exposure to the index they tack, meaning they pay a multiple of the performance that index. For example, an ETN that offers 2x leverage will deliver twice the performance of the index it tracks.
Inverse ETNs pay the opposite of the performance of the index it tracks, while a leveraged inverse ETN pays a multiple of the opposite of the index’s performance.
Some of these alternate ETNS achieve their performance goals daily and their leverage or inverse values are reset at the beginning of each new day of trading.
Generally speaking, leveraged and inverse ETNs are not suitable as buy-and-hold investing tools. Instead, many experts view these instruments as wagers for short-term gain.
Confused About ETNs?
If you or someone you know is confused about the value or performance of an ETN, please contact us. Free and confidential consultations are available with one of our securities attorneys by calling toll-free (866) 981-4800 or filling out the form to the right.