Exchange traded notes (ETNs) have not been able to emerge from the shadow of exchange traded funds (ETFs). This s largely because of the extra risk and limitations that entail from investing in them. But ETNs have many benefits you may not have considered.
ETNs exist in far fewer numbers than ETFs, and they have attracted about 1% of the assets held in ETFs. One factor that could explain their lesser popularity is the risk associated with investing in them. ETNs are essentially debt instruments, meaning that if the issuing bank goes under, you’ll have to get in line with other creditors for your money. (Differences between ETFs and ETNs).
Despite the risk, though, ETNs do have some big advantages that could make them appealing to investors, Karan Damato for The Wall Street Journal says. These include:
- Favorable tax treatment for investors seeking commodities exposure. Many commodity ETFs buy futures contracts. Under tax rules, in most futures owe tax on any appreciation each year, even if they don’t sell. Sixty percent of any gain is taxed as a long-term capital gain; 40% is taxed as a short-term gain, at ordinary-income rates. For ETNs, gains are taxed only upon sale, and gains on commodity ETNs held longer than a year are considered long-term, currently subject to a maximum 15% tax rate. The IRS hasn’t specifically addressed the tax treatment of the notes, though, so this could change. Consult your tax professional for advice.
- Unlike traditional mutual funds, both types of exchange-traded products can be bought and sold all day long like individual stocks.
- ETNs offer access to tougher areas of the market such as coffee, aluminum and copper. (Check out the coffee ETN here).
- There’s fairly low credit-risk on notes from larger banks, such as Barclays or Deutsche Bank.
- Another potential advantage of ETNs is that investors don’t have to worry about “tracking error.” This risk is borne by the issuer. (Why your portfolio may crave an ETN).
For more stories about ETNs, visit our ETNs category. Some of the largest ETNs include:
- iPath Dow Jones UBS Commodity ETN (NYSEArca: DJP): up 14.4% year-to-date
- iPath S&P GSCI Crude Oil (NYSEArca: OIL): up 0.4% year-to-date
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.