A conversation about exchange traded products typically involves exchange traded funds, or ETFs, but , overlooking exchange traded notes, or ETNs, in the process.
Not only do ETNs offer exposure to a broad range of assets, in select asset classes, ETNs can be the preferred avenue for gaining exposure. ETNs are not complex.
An ETN is a bond security. A issuing financial institution promises to pay ETN investors a return on a benchmark index before the ETN matures. Additionally, some ETNs provide current distributions to investors. Since ETNs are a type of debt security, investors will have to watch out for the credit worthiness of the issuing bank. [What are ETNs?}
Although it is from a much lower base, ETNs are gathering assets at a more impressive clip on a percentage than their ETF brethren. “Total ETN assets jumped 47 percent, or $8 billion, over the past 12 months, to $25 billion, compared to about 25 percent for ETFs,” reports Eric Balchunas for Bloomberg.
When it comes to performance, some ETNs have justified the inflows. Of the 10 best non-leveraged ETPs this year, four are ETNs, a group that includes the best ETP, the iPath Dow Jones-UBS Coffee Total Return Sub-Index (NYSEArca: JO).
Other high-flying ETNs this year include the iPath Dow Jones-UBS Nickel Total Return Sub-Index ETN (NYSEArca: JJN) and the iPath Dow Jones-UBS Natural Gas Total Return Sub-Index ETN (NYSEArca: GAZ). [Ag ETFs Love the Weather]
However, the major driving force behind the rise in ETN assets, as Balchunas reports, has been master limited partnerships, or MLPs. MLPs have soared in popularity among income investors, leading to the subsequent increase in the popularity of MLP ETFs.
But MLP ETFs come with some thorny tax issues. MLP ETFs that hold more than 25% of their portfolio in MLPs are structured as C-Corporations in order to track an underlying MLP-related index. Due to the C-Corporation structure, they must pay corporate income tax on distributions before passing them to investors. Consequently, MLP ETFs may incur higher fees that would cut into overall performance, leading to an underperformance compared to the underlying benchmark. [MLP ETF Tax Issues]
Like a regular equity-based ETF, an MLP ETN, such as the JPMorgan Alerian MLP Index ETN (NYSEArca: AMJ), tracks an index. Fortunately, MLP ETNs are taxed the same way as their ETF counterparts.
“In general, the ETN is used by investors more interested in a higher total return; investors who are more interested in the income or who don’t want to take on credit risk use the ETF,” writes Balchunas.
Other well-know ETNs include the ETRACS Alerian MLP Infrastructure Index ETN (NYSEArca: MLPI) and the iPath MSCI India Index ETN (NYSEArca: INP).
JPMorgan Alerian MLP Index ETN
ETF Trends editorial team contributed to this article.