Exchange traded notes (ETNs) have seen some chinks in their armor this year, in the wake of the credit crisis and a commodities slowdown.
ETNs, which are close cousins of exchange traded funds (ETFs), have been bleeding investor assets after being hit with a double-whammy of credit jitters and declining commodity prices, says Ian Salisbury for The Wall Street Journal.
In September, investors extracted about $460 million from the 90 ETNs tracked by fund researcher Morningstar, a chunk of their $5.5 billion in overall assets. Although October numbers aren’t calculated yet, the general feeling is that they could be worse.
The largest ETN is the iPath Dow Jones AIG Commodity Index Total Return (DJP), which reported that about 12% of outstanding shares were redeemed during the month through Thursday.
While money has indeed been coming out of ETNs, commodity prices have declined across the board. I spoke at the Inside Commodities Conference in New York this week, where there was a great exchange of ideas and opinions. One of the questions at the conference was whether exchange traded products fueled commodity prices in 2007 and 2008, and the general consensus seemed to be yes. As those markets have corrected, there have been redemptions in commodity funds. Regardless of supply and demand issues, these ETNs did what they were supposed to do.
Lisa Dallmer, NYSE Euronext senior vice president, noted that there are $38 billion in commodities-based exchange traded products. Considering this, a nearly $500 million decline doesn’t seem quite as bad.
As far as credit risk, while each ETN has it, we feel that ETNs are overall acting as they should and that the issuers behind them are secure. An ETN is not backed by assets, however. They are unsecured debt by the issuing form and there is credit risk. If an ETN liquidates, there would only be money to give back to investors if there was money left over after the secured creditors were paid.
ETNs may also be victim, like other fixed-income products, to the overexpansion during the bull market, and will face a tough period trying to sell themselves now. The total number of ETNs available ballooned from just four in 2007 to 90 as of August 2008. ETNs are attractive, because they give investors a way to access areas of the markets that were previously off-limits or very expensive. But they’re hurting along with the broader markets these days.
There are many questions about what the future will bring with unknowable answers. Will commodities make a strong comeback? When the market recovers, will investors come back to ETNs? Will investors ever recover from their skittishness about the credit markets? Only time will tell.