The latest hot product to come out of Wall Street is the Exchange Traded Note (ETN). It sounds a lot like the Exchange Traded Fund (ETF), and like an Exchange Traded Fund it trades through the day on stock exchange. Also, like an ETF it tracks an index. But buyer beware, although the clever bankers might have made this product seem similar it is something very different indeed.
An Exchange Traded Fund tries to replicate the performance of an index by purchasing the assets which make up the index, and it is thus an equity investment. It is unable to exactly replicate the index and is subject to tracking error. An ETN is an unsecured promissory obligation, which is issued with the guarantee of a financial institution. Basically the issuer says it will pay the investor an exact match of the index’s performance with no tracking error. It is an investment in a promise rather than an underlying basket of assets, and is a debt obligation. Thus an ETN has a counterparty risk, and if you don’t think this is a significant factor then you should consider that the counterparties to Lehman brother contracts are still trying to get their money back.
Another important difference is that they are regulated differently, with Exchange Traded Funds regulated by the 1940 Investment Company Act, and ETNs regulated by the 1933 Securities Act. This means that can have different characteristics as financial instruments, with ETNs able to make use of derivatives. Exchange Traded Notes have a fixed date of maturity, whereas Exchange Traded Funds can be open ended.
There are so many products out there trying to capture the imaginations of the individual investor that it is sometimes easy to forget the importance of researching each one and investigating the risks and rewards associated with each. When you come across complex financial products such as the one discussed in this article one sensible option can be to discuss the pros and cons with an independent financial adviser, but make sure they are indeed independent and not tied in any way to the bank that is selling the product. Tied advisers are sometimes motivated by commissions and they are conflicted from providing the independent advice that may best suit the individual looking to save a nest egg, for retirement, or purchase of a home to live in. These are important considerations when you are investment, that is for sure.
For more information about exchange traded notes then see http://exchangetradednotes.co.uk