The ETN Tax Advantage: Do Individual Investors Care?

One of the curious things about ETNs is that they're not more popular.

Sometimes I wonder if individual investors even care about taxes. You see them investing in tax-inefficient mutual funds all the time. And even within the ETN space, the asset flows to-date belie a strong emphasis on tax issues.

Investors should care. The tax benefits of the ETNs are huge. As a shareholder, I care about the tax issues.

But look at the assets for the eight iPath ETNs:

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These things are a success because of two products: 1) The Dow Jones-AIG Commodity ETN, which has $2.3 billion out of a total $3.6 billion in assets; and 2) the MSCI India ETN, which has $813 million.

That doesn't suggest a focus on tax to me. India isn't really tax-advantaged at all, and while much is made of the growth of DJP—now the biggest commodity ETF/ETN on the market—to my mind, its success is tied to the underlying index, not the tax-advantaged structure.

Consider competing indexes. The GSCI is tremendously overweight energy, and in particular oil, which due to contango wasn't a good bet until recently. Meanwhile, the DB Commodity Index—the underlying index for the PowerShares DB Commodity Index Fund (DBC)—isn't well-known by investors, and with only six commodities, may not offer enough diversification for investors. (I happen to very much like DBC, and particularly its roll strategy, but I don't think investors understand its benefits as well as they should.)

A better window into investors' thinking is offered by looking at the iPath S&P GSCI Commodity ETN (GSP) and the iShares GSCI Commodity Index ETF (GSG). Those two products track identical indexes and offer similar exposure. Of the two, GSG ... the ETF ... has more assets: $366 million vs. $229 million.

Similarly, the three currency ETNs provide very similar exposure to comparable CurrencyShares ETFs. But while the currency ETNs have a net $208 million in assets, the comparable CurrencyShares have $2.08 billion.

Investors should care about the tax issues. Some of these asset classes are woefully tax-inefficient, and the ETNs offer real benefits (for now).

But do investors actually think about taxes? Do they even understand the tax implications of currencies, commodities and bullion-based investors? Despite my best efforts (grin), I'm not so sure.

Written by Matthew Hougan

Comments

[Frank Hecker]

Maybe there are two explanations here: Lots of individual investors don't even know what ETNs are and how they work, let alone any potential tax advantages they might have. (I was in this category until relatively recently, despite reading Seeking Alpha on a regular basis.) Of those individual investors who do know about ETNs and the tax advantages thereof, based on recent commentary some might likely be concerned that the tax advantages will be taken away by Congress and the IRS, and/or that individual investors using ETNs might be subject to additional IRS scrutiny, up to and including audits. Such people might be reluctant to be pioneers in terms of investing in ETNs, and prefer to wait until there's more clarity. (I'm in this category right now.)