Exchange traded funds (ETFs) have been overshadowing their close relative, the exchange traded note (ETN). Investors could be missing out on this nifty alternative investment vehicle.

At the end of September, U.S.-listed ETNs held $6.9 billion in assets, compared with the $697 billion held in ETFs, writes Matt Hougan for IndexUniverse. (What are ETNs?)

There are three key advantages they enjoy:

  • When ETNs first came to the market, the investment vehicle proved to be popular among investors who were looking for access to difficult-to-target markets, such as commodities and certain foreign markets. Investors flocked to funds such as the iPath MSCI India (NYSEArca: INP) and iPath Dow Jones-UBS Commodity Index ETN (NYSEArca: DJP). There are ETFs that target these areas now, but ETNs still cover certain areas not yet covered by ETFs.
  • ETNs promise perfect tracking – an investor receives the full return of the benchmark, minus costs. Commodity ETFs on the other hand do show some tracking errors. Any tracking error in an ETN is borne by the issuer; tracking error in ETFs are borne by the investor.
  • ETNs also have the benefit of being treated like a zero-dividend stock for tax purposes. This means that you don’t pay taxes until you sell, and holding a commodity ETN longer than a year only costs an investor 15% long-term capital gains taxes when sold. Futures-based commodity ETFs are treated like futures, which means gains are marked-to-market each year and investors pay taxes on gains at 60%/40% long-term/short-term capital gains tax rate. Be sure to consult your tax professional for advice. (Are you ready for the taxman?)

A deterrent for ETNs investing is that they are unsecured debt notes. The ETN’s value depends on the credit of an issuing bank – if the bank bankrupts, you’re out of luck. Most ETNs, however, offer daily redemptions at net asset value. Potential ETN investors should note that the CFTC’s plans for regulation in the commodities market could force some ETNs to close down, but this remains to be seen. (Differences between ETNs and ETFs)

For more information on ETNs, visit our ETNs category.

Some of the more heavily traded ETNs include:

  • iPath DJ AIG Lead TR Sub-Idx ETN (NYSEArca: LD): up 128.9% year-to-date
  • iPath DJ AIG Sugar TR Sub-Idx ETN (NYSEArca: SGG): up 57.7% year-to-date
  • iPath Dow Jones-AIG Commodity Idx TR ETN (NYSEArca: DJP): up 16.2% year-to-date
  • iPath MSCI India Index ETN (NYSEArca: INP): up 82.4% year-to-date
  • iPath S&P GSCI Crude Oil Ttl Ret Idx ETN (NYSEArca: OIL): up 16.1% year-to-date

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.