Exchange traded fund investors may at some point come across exchange traded notes when filling out an investment portfolio. However, one should understand that ETNs are not ETFs, and the notes come with their own set of risks.
Similar to index-based ETFs, ETNs also track some sort of index as part of their investment strategy. ETNs though are a type of debt note that trades on an exchange.
There are some caveats that ETN investors should be aware of. ETNs are debt securities issued by financial institutions that promise to pay the return of an index, minus fees and taxes. Consequently, investors are exposed to the credit risk or the possibility the underwriting bank goes bankrupt. The note can be vulnerable if the issuer gets into financial trouble, otherwise known as a default. With an ETN, an investor can lose some or all of their investment if the ETN issuer goes under.
Moreover, the underwriting bank may halt or impede new creations, which may cause an ETN to act more like a closed-end fund. Consequently, if there are no new creations and investors keep piling into an ETN, a note could experience high premiums to its underlying value.
For instance, the iPath Crude Oil Futures ETN (NYSEArca: OIL), which has $627.3 million in assets under management, is currently trading at a 10.9% premium to its NAV, according to Morningstar data. The oil ETN was trading at a premium of as high as 41% last Tuesday.
Barclays Bank PLC, the underwriting bank behind the iPath ETN line, recently issued a warning on its OIL ETN, urging investors to “exercise extreme caution” when buying or selling ETNs that trade at a premium over its NAV, reports Daisy Maxey for the Wall Street Journal.
Investors buying an ETN at a premium “may experience a significant loss if they sell the ETN at a time when such premium is no longer present,” Barclays warned Friday