The exchange traded note (ETN), relative of the exchange traded fund (ETF) is all grown up, and some say the notes carry less tracking error than the predecessor. Like an ETF, an ETN tracks a benchmark and trades on an exchange. However, ETNs do not hold stocks, bonds or futures contracts. They are senior, unobscured debt, reports Lawrence Carrel for TheStreet.com. If an issuer fails to succeed, then the investors might not get paid. So far, the two investment banks that offer ETNs are Barclays and Bear Stearns.

ETNs avoid two downsides that ETFs have. First, an ETN’s returns is less likely to move out of line with its benchmark index because tracking error for an ETN is the difference between the return of the benchmark and the management fee. Second, ETNs feature even better tax efficiency than ETFs. "Although there’s some uncertainty about the tax status of their annual returns. For now, however, investors don’t incur taxes until they sell them, potentially generating a capital gain." says Carrel.

Tags: Bond ETFs, ETNs