Why Investors Use ETNs

As with any investment vehicle, ETNs have their advantages and disadvantages.

The following is a non-exhaustive list of such advantages and disadvantages.

Some advantages:

  • No tracking errors. ETNs give investors a broad-based index without any tracking error to the index.  Although ETNs track an index, the return is not based on the underlying securities.  The ETN issuer guarantees the holder a return that is an exact replica of the underlying index.  The bank also agrees to pay large shareholders the exact value of the note on a weekly basis through redemption, which helps the ETNs track very closely to the underlying index return.
  • Liquid structure. ETNs can be bought and sold during normal trading hours on NYSE Euronext’s Arca and European exchanges.  For institutional size redemption, investors may offer their ETN for repurchase by the issuer on a weekly basis.
  • Access to new markets. ETNs provide access to hard-to-reach exposures, such as commodity futures and emerging markets.  In particular, they provide opportunity for the individual investor to gain exposure to these types of investment strategies in a cost-efficient way.

Some disadvantages:

  • Bankruptcy risk. In the case of a fund bankruptcy, ETN holders may not have a claim on the underlying assets. Since the ETN sponsor doesn't necessarily hold the underlying assets tied to a fund's payout, ETN investors may not have recourse if an ETN issuer goes bankrupt.
  • Subject to downgrade risk. Since holders of ETNs are subject to counterparty risk, their ETN investment could lose value if the underwriter of the note experiences a credit downgrade, even if the fundamentals of the underlying note remain strong.