By Daniela Pylypczak
Under the umbrella of exchange-traded products, ETNs have attracted far less interest than their ETF cousins and now represent only a small portion of total ETP assets. Exchange-traded notes are debt instruments linked to the performance of an index, and as a result there won’t be any tracking error with these products. Although these investment vehicles expose their holders to the credit risk of the issuing institution, many offer certain tax advantages that may be appealing to many investors [see also 10 Surprising ETF Stats From Mid Year ETF Data].
As the financial world continues to embrace the exchange-traded note structure, issuers have been ramping up their line ups, contributing to the the accelerating growth of the industry. Investors distanced themselves from ETNs during the recent crisis (and rightfully so; the credit risk component no doubt gave many a bit of additional anxiety). But ETNs are becoming increasingly popular in a wide variety of asset classes, as investors are embracing these vehicles as a more efficient tool in many instances. ETN assets now exceed $16 billion, and this corner of the market is home to some of the fastest growing exchange-traded products.
Below, we profile the five of the most popular ETNs out there:
Alerian MLP Index ETN (AMJ)
Over the last few years, interest in Master Limited Partnerships (MLPs) have skyrocketed, given the sector’s attractive high yields and lucrative returns. JP Morgan’s AMJ has helped revolutionize investments made in this commonly overlooked corner of the domestic energy market, providing investors with exposure to publicly-traded MLPs without the nuances of tracking error. Since inception in 2009, the fund has amassed more than $4.6 billion in assets and exchanges hands over 1.6 million times a day [see Guide To MLP ETFs (And ETNs)].
The MLP market is one example where the ETN structure can deliver meaningful benefits over otherwise similar ETFs. ETNs deliver favorable tax treatments to any capital gains in the underlying securities, while ETFs focusing on MLPs will accrue tax liabilities as the component stocks appreciate in value. It should be noted that JPMorgan recently announced that it would halt new creations of AMJ, which could eventually lead to this note trading at a premium to its NAV. As such, it is advised to carefully study the NAV before establishing a position.
Dow Jones-UBS Commodity Index TR ETN (DJP)
This ETN, with nearly $2 billion in assets, is one of the most popular and preferred products for investors looking to achieve broad-based exposure to the appealing world of commodities. One of the most attractive features of DJP is that its unique selection methodology ensures that energy commodities are not overweighted, a common drawback of many broad commodity ETPs. The resulting portfolio offers a more balanced approach to the space, providing exposure to a diversified basket of commodities, including energy resources, precious metals and agriculture.
DJP similarly offers an advantage compared to ETFs holding commodity futures contracts. Unlike ETFs, which are commodity pools as far as the SEC and IRS are concerned, ETNs will not deliver a K-1 or force investors to pay taxes on gains annually regardless of whether the shares were sold. Moreover, long term capital gains will be taxed at a more favorable rate.
S&P 500 VIX Short-Term Futures ETN (VXX)
Leading ETN issuer Barclays iPath’s VXX is perhaps the most popular option for investors wishing to gain access to the heavily traded world of equity market volatility. Considering the number of brutal shocks markets have experienced since the crash of 2008, this ETN has grown to be one of the most useful trading instruments, allowing investors to make a potentially rewarding play during turbulent and uncertain times. With a portfolio worth over $1.6 billion in assets and an average daily trading volume of a staggering 50 million shares, this mega ETN continues to be the king of volatility focused products.
VXX can be one of the most efficient forms of protection when stocks stumble, as this ETN has a strong negative correlation with the S&P 500. However, it is important for investors to realize that VXX does not represent a spot investment in the VIX, but rather is linked to an index comprised of VIX futures, meaning that the performance of this fund may vary significantly from a hypothetical investment in the VIX.
DB Gold Double Long ETN (DGP)
For investors with a bullish short-term outlook for gold, DGP certainly delivers a hefty punch with its 2x long leveraged position in the precious metal. This powerful tool has gained significant popularity since its inception in 2008 and has accumulated just over $480 million in total assets. Considering DGP’s leverage, investors with low risk tolerance or a buy-and-hold strategy may want to avoid this fund. For the more sophisticated investors however, DGP can represent a way to profit from swings in the price of gold [see Gold ETNs Provide Case Study In Monthly Leverage].
MSCI India Index ETN (INP)
With many emerging market ETPs delivering some eye-popping returns over the past few years, this ultra popular fund has become one of the top picks for investors wishing to gain access to the world’s second most populated country: India. The fund seeks to represent approximately 85% of the free-float-adjusted market capitalization of equity securities by industry group within India. And as such, INP’s portfolio reaches nearly every corner of the Indian equity market, including the financials, information technology, energy, and materials sectors.
Though India is home to a large stock market, many smaller Indian stocks still experience liquidity issues–meaning that daily trading volumes are relatively low. That can translate into tracking error for ETFs that seek to replicate benchmarks that include these stocks, which may be undesirable from the perspective of some investors. Since INP is an ETN that simply mimics the performance of the underlying benchmark–there is no underlying basket of stocks–there is no risk of any tracking error.
Since its launch in 2006, Barclay iPath’s INP has accumulated more than $430 million in total assets and currently trades at a daily average volume of just over 81,500 shares.
Disclosure: No positions at time of writing.
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