One of the ways in which exchange traded notes (ETNs) differ from exchange traded funds (ETFs) is that they’re debt instruments. This means that you’re taking on the credit risk of the issuer, and if the issuer goes under, you lose your money.

The demise of Lehman Brothers (LEH) serves to illustrate some of the risks that investors need to be aware of. In February, Lehman had launched three ETNs tracking a private equity, agricultural commodities and a broad-based commodity index. What will happen to these funds isn’t clear yet, but the industry is watching closely. Whatever does happen could have implications for how investors approach ETNs going forward.

According to Ian Salisbury for Dow Jones Newswires, investors have put $7.2 billion into ETNs since their invention by Barclays in 2006.

While ETNs are debt securities that are usually issued by investment banks, their structure gives them greater flexibility. They’re easier to design around hard-to-reach assets such as commodities or countries that have limits on foreign investment, such as India.

But investors need to know that if the issuer goes under, there’s little recourse. Salisbury points out that the question might be an academic one: none of the ETNs issued by Lehman has more than $6 million in assets. Money in the funds probably represents capital kept there by specialist firms who are making sure they trade in an orderly fashion.

Firms with more popular ETNs, it should be noted, have significant assets and trading volumes. Both Barclays and Deutsche Bank appear to be financially sound, and their ETNs are issued by units with investment-grade credit ratings.

Trading in the funds was halted on Monday:

• Opta Lehman Brothers Commodity Index Pure Beta Total Return (RAW)
  
• Opta Lehman Brothers Commodity Index Pure Beta Agriculture Total Return (EOH)
  
• Opta S&P Listed Private Equity Index Net Return (PPE)

Tags: Agriculture, EOH, ETNs, PPE, RAW

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