Exchange traded notes (ETNs) are distant relatives of the exchange traded fund (ETF) and they come with their own unique issues attached.

Matthew Hougan for Index Universe points out that while the credit risk is small, it’s still there. The Bear Stearns (BSC) fiasco showed that crazy things can happen. When you invest in an ETN, you’re investing in a 30-year debt instrument. They are a promise by the provider to pay the investor the amount reflecting a change in the underlying index.

ETNs do have some tracking error, but the difference is that they will never trade below the value of their index. This is part of what the provider offers to the investor. However, there’s no guarantee that they won’t trade above their net asset value (NAV). With ETFs, any tracking error is borne by the investor.

Late last year, the iPath MSCI India (INP) traded at a big premium to its NAV after the government clamped down on foreign investing.

The issue of taxes and ETNs is still a matter of ongoing debate. While the IRS has ruled on taxes regarding foreign-currency ETNs, they don’t appear to be any closer to a decision, according to Stephanie Carreras at Barclay’s. Open discussions are taking place until the middle of this month.

Tags: Currency ETFs, ETNs, India