Exchange Trade Notes: What Are They?
So you might no all about Exchanges Traded Funds, but how about the new kid on the block: Exchange Traded Notes. Well, ETNs are quite different from ETFs, and this article will look at how.
An Exchange Traded Note is an unsecured promissory obligation issued by a financial institution. The return that is paid on the note is linked to a specified index. So really it is like a bond in that you are taking on the credit risk of the issuer, and like an Exchange Traded Fund in that you get the returns of an index. It is unlike a bond in that the coupon is variable, and it is unlike an Exchange Traded Fund in that there is no tracking error. So you eat some credit risk to eliminate tracking error.
ETNs can track absolutely any index at all so they offer a far greater diversity than ETFS. Exchange Traded Notes have a fixed maturity date, and they can also be traded throughout the day just like Exchange Traded Funds.
If you decide that this is the asset class for you, then keep an eye out for Exchange Traded Notes that trade at a discount to their indicative Net Asset Value as this is a sign that they may be a credit risk. This alone is not a foolproof method, and the only real way to evaluate the credit risk is to engage in fundamental research into the issuer.
Because of the way Exchange Traded Funds are set up it means that they can provide access to a wide range of foreign, currency and commodity markets. It used to be the case that only large investors could access such markets, but now they have reached main street.
In terms of regulation you should note that ETFs are subject to the Investment Company Act of 1940, whereas ETNs fall under the Securities Act of 1933. There are two main differences that result from this, one is that the ETN can offer access to more exotic assets, and the second is that an investor in an ETN does not have any claim to the assets that constitute the index, whereas the investor in the ETF does.
When it comes to taxation, ETNs only incur a taxable event when an investor sells their shares. If the shares are held for less than a year this is ordinary income, if it is for more than a year then this is treated as long term capital gains.
If you are interested in what an ETF Analyst has to say about ETFs, ETNs and other money products then see: http://hubpages.com/hub/ETF-Analyst-Leveraged-ETFs-are-Toxic
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