Exchange traded notes can be confused with exchange traded funds, but they are a different instrument entirely.
“ETNs come with an added layer of uncertainty. Whereas ETFs are subject to market risk, ETN investors take on both market risk and credit risk. ETNs are essentially unsecured bonds backed by the financial strength of the issuer,” Richard Moroney reports for MoneyShow. [ETFs Vs. ETNs – What is the Difference]
ETNs are traded on an exchange, just like an ETF or single stock. Investors have the choice to hold the note until maturity, and they are given a cash amount equal to the principal amount, depending on the market movements. The issuer has control of the ETNs credit rating, which can fluctuate with the credit rating of the issuer. An ETN does not own anything it is tracking, reports Moroney. [Comparing ETFs and ETNs]
ETNs are generally used by aggressive or seasoned investors. Since an ETN is takes on both market risk and credit risk, they are more volatile than an ETF. Should the issuing company go bankrupt, the return promised to the investor is not fulfilled.
ETN can access areas of the market more effectively than an ETF, such as commodities and currencies. Plus, the tax treatment for an ETN focused on commodities is less punishing. With a commodity ETF, there are distributions, possible short-term capital gains on futures contracts and long term capital gains. [Investors Warned on ETN Risks]
A plus of an ETN lies in the fact that there is no tracking risk and ETNs are treated as prepaid contracts. Plus, there are no distributions with notes. Any difference of an ETF is treated as a capital gain, and are classified as a long term gain, which is more favorable than a short-term gain. Tax treatment is one the biggest differences between an ETF and an ETN, reports Investopedia.
Tisha Guerrero contributed to this article.