Exchange Traded Notes Explained
Unlike exchange traded fund (ETF), which has become a popular investment vehicle for investors who want both the broad diversification of a mutual fund and the flexible pricing and trading of a stock, exchanged traded note (ETN) is relatively new and little known. According to Investopedia, ETN is
A type of unsecured, unsubordinated debt security that was first issued by Barclays Bank PLC. This type of debt security differs from other types of bonds and notes because ETN returns are based upon the performance of a market index minus applicable fees, no period coupon payments are distributed and no principal protections exists.
Currently, the only ETN issuer is Barclays Bank, which also happens to be the largest ETF provider.
Difference between ETN and ETF
From the above definition, we know that ETNs are debt securities, not equities. Thus, like notes and bonds, a ETN has a maturity date. On the other hand, ETN also shares some common features with ETF, including:
- Both ETN and ETF are structured like a mutual fund that tracks an index;
- They are traded on exchanges like stocks.
The main difference is that, if held to maturity, Barclays promises to “repay the amount of your investment plus (or minus) the return of the index that the ETN tracks,” minus the note’s management fee, says an article, When exchange-traded notes make sense, in the July issue of Kiplinger’s Personal Finance magazine.
In terms of returns, since all the ETNs Barclays now offers have 100% correlation with their respective indexes, investors could get better return from ETNs if they hold the securities till maturity than from the ETF counterparts because, generally, ETFs guarantee at least 95% correlation with their underlying indexes.
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Is ETN the right investment?
The biggest benefit of ETN is, according to Barclays, that ETN doesn’t make taxable distributions. All the investment gains, such as dividends and interests, are lumped into the fund’s total return. Therefore, ETN investors will only face taxes at the time sell their shares, or redeem them when they mature. In this case, a favorable 15% tax rate will be applied for gains from shares held longer than one year, making ETNs a good choice for taxable investments.
As a new product, ETN has a very short history. The lack of tracking record could be a concern for investors who are considering adding ETNs to their portfolios. In addition, investor’s investments and any returns will depend on Barclays’ ability to deliver what it has promised to investors. Better pray the bank will still be around 30 years from now .
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