Exchange-traded funds (ETFs) may have the spotlight, but the lesser-known exchange-traded note (ETN) should not be forgotten — or is that exactly what is happening in the capital markets right now? The rise of ETFs could be spelling doom for ETNs, which have experienced a number of closings thus far in 2020.
“Exchange-traded notes, which are very different from similar sounding exchange-traded funds, have become an asset class in extremis, falling out of favor with many investors and issuers,” a Wall Street Journal article said. “Since the start of the year, at least 47 ETNs have closed or been liquidated, bringing the number trading on major exchanges to 125 as of Sept. 30, according to ETF Think Tank, a research service.”
A number of market analysts are forecasting that this trend will continue, especially when ETNs don’t have the transparency disclosure that ETFs have when it comes to their holdings. Additionally, each investment vehicle comes with their own nuances.
“ETFs hold securities that are priced throughout the day, and the fund’s share price usually reflects the value of the holdings,” the WSJ article explained. “In contrast, ETNs are bank-issued unsecured debt obligations, essentially IOUs, that pay a return based on the performance of an index. The bank, however, doesn’t own any of the securities or derivatives to facilitate this index tracking, so its computes the price internally. This price can be different, sometimes wildly so, from the market price, especially if demand for the ETN is so strong the bank can’t create new shares fast enough.”
ETNs should only be utilized if “you’re a sophisticated investor, and you can drill deep into exactly how that index should be priced, and that ETN should be priced, and have a law degree and can figure out all the scenarios,” said Dan Weiskopf, a portfolio manager with Toroso Investments and an ETF strategist with ETF Think Tank.
With the Covid-19 pandemic, a heavy dose of volatility rained down on investors and ETNs generally tend to provide more exposure to volatility versus ETFs.
“We’ve had many cases now of ETN issuers simply deciding it was too hard to keep taking new assets in a given strategy,” says Dave Nadig, chief investment officer and director of research of ETF Trends and ETF Database. Nadig also noted that ETNs are “incredibly anti-investor” since “the liquidity generally dries right up, leaving anyone who remains long with few options to exit their position other than pay prices well outside fair value.”
For more market trends, visit ETF Trends.