What are ETNs and what are their benefits.

/ The article is intended for novice traders. More training materials can be found here: https://www.varchev.com/trading-uni.htm. /

Stress in the banking sector started last week and the extraordinary sale over the weekend of Credit Suisse to the large and rival UBS, the topic of the complexity of the sector is becoming more and more relevant.

In this regard, we will look at a relatively small but very exotic product of the exchange-traded product (ETP) universe, namely exchange-traded notes (ETN). ETNs are a boutique product that many retail investors may not be aware of. Let’s take a look at what ETNs are and whether they have a place in our portfolios.

What is an ETN and what makes it different from an ETF?
In practice, ETFs and ETNs have a lot in common. Both products are designed to track an underlying asset, both often have lower expense ratios than actively managed mutual funds, and both are traded on major exchanges just like stocks.

The main difference lies deeper.
When you invest in an ETF, you are investing in a fund that actively follows the structure of the benchmark it tracks. This asset can be an index, sector, debt, commodities and metals such as gold, futures or a combination of assets.

While an ETN is more like a bond. ETN, in the simplest terms, represents a portion of subordinated, unsecured debt issued by an institution /bank/. Just like bonds, ETNs can be held to maturity or bought or sold as desired. Of greatest importance to ETNs is the type of asset, with subordinated debt, where things can get interesting. If you want exposure to commodities, carbon certificates, volatility or leveraged returns, an ETN is the right instrument. The complexity comes from the correct assessment of the issuer’s credit rating, as in the event of the issuer’s bankruptcy, the ETN investor could suffer serious losses.

For this reason, before investing in an ETN, researching the issuer’s credit rating is of cardinal importance. If the issuer receives a downgrade, the ETN’s price is likely to experience a decline unrelated to the underlying asset it tracks. Trading is more risky, but gives opportunities for good profits, with a proper understanding of the tools.

Advantages of ETNs
ETNs provide exposure to exotic asset classes. ETNs are more efficient at replicating a benchmark than most ETFs and have more favorable tax treatment.

ETNs have a notable advantage over ETFs given their lower tracking variances. ETFs achieve varying degrees of success in tracking their respective benchmarks. Most ETFs have some deviation from the index they track due to various factors, such as timing, time of liquidation or acquisition, and expense portion.

Tracking error is virtually eliminated with ETNs because the issuer agrees to pay the full value of the asset (minus the expense ratio). The ETN pays investors 100% of the value of the tracked asset once maturity is reached. There is no tracking error because the issuer itself does not actively manage the benchmark, but owns it through subordinated debt.

Because the ETN does not pay dividends or interest income (unlike some ETFs), there are no annual taxes due. ETN investors pay capital gains taxes only when they sell the security.

What are the most popular ETNs?
There are currently 83 ETNs available in the market issued by six issuers. The issuers with the largest number of ETNs are: UBS/Credit Suisse (33); Barclays/iPath (25 items); MicroSectors (19 issues) issued by the Bank of Montreal. They represent a total of 93% of the total capitalization of the ETNs. The largest ETNs are: J.P. Morgan Alerian MLP Index ETN (AMJ) ($2.5 billion), followed by MicroSectors U.S. Big Oil Index 3X Leveraged ETN (NRGU) ($1.1 billion) and MicroSectors FANG+ ETN with 3X Leverage (FNGU) /$964 million/

Who are ETNs good for?
ETNs are a more sophisticated and boutique product than ETFs, requiring a wide range of market information and expertise to make a decision. They provide an opportunity for good diversification of the portfolio, to asset classes to which the retail investor does not otherwise have access and have better taxation. They are suitable for advanced and experienced investors, with a large portfolio, looking for diversification opportunities.

/ The article is intended for novice traders. More training materials can be found here: https://www.varchev.com/trading-uni.htm. /