Investors received another warning on the credit risks of exchange traded notes and why the products shouldn’t be lumped together with exchange traded funds.
“The most important difference between ETNs and ETFs is what they represent. An ETF, like a mutual fund, holds a basket of securities that the ETF holder, of course, owns indirectly,” according to U.S. News & World Report. “When you buy an ETN, by contrast, you are not buying a bundle of securities; you are lending money to the bank that issues the ETN, and your loan is unsecured. It’s an elaborate IOU.”
At the end of July, U.S.-listed ETNs held assets of $17.5 billion, according to ETF Industry Association data. They are a small fraction of the ETF business, which controls about $1.2 trillion.
“Because they look similar to ETFs, many investors probably own ETNs without realizing the difference,” said Matt Hougan, editor of IndexUniverse.com, in a report earlier this year for CNNMoney. [ETNs are Not ETFs]
There were 1,268 ETFs and 218 ETNs as of July 31.
The ETN vehicle offers “intraday trading, is theoretically immune to tracking error, and provides access to asset classes that are otherwise difficult for average investors to buy,” U.S. News & World Report said. “Most observers agree that ETNs offer a tax advantage, in that there are no periodic income or capital distributions, and gains are treated as capital gains, which can carry a low 15% federal tax rate for holdings of more than one year.”
The bottom line for investors is that ETNs are different from ETFs and have sophisticated features that they need to understand. [FINRA Warns on ETN Risks]