Do Investors Need ETNs?

By Murray Coleman

Two sides are forming. Both seem entrenched and both are putting much of the blame on those of us in the media.

Whether such notoriety is really deserved, reporters are smack dab in the middle of this one.

At issue is whether exchange-traded notes, the latest marketing term created by the hyper-growth exchange-traded securities industry, are really much more than a bunch of hype. Does the world really need another form of exchange-traded funds?

Both ETFs and ETNs hold baskets of securities. The argument for ETNs is that they can go where most ETFs can't go - niche markets such as currencies and commodities. The idea is that by issuing notes replicating returns of an underlying index, shareholders can avoid pitfalls of actually buying portfolios of securities in often illiquid markets. Notes also can be used much more readily to purchase futures contracts and other more exotic financing vehicles to gain exposure to different asset classes.

But some in the industry are complaining that ETFs can do much the same. In fact, they are in many cases. Critics contend that ETNs are simply a new brand name that in essence repackages the flooding fields of ETFs. I've also heard arguments that since ETN providers hold their own notes in many of these newer products (Barclays, Deutsche Bank, etc.), the main innovation being brought to market is a way for big asset managers and banks to retain more assets directly. It can also help those issuing notes to eliminate more middlemen in transactions.

Another point of contention seems to be that a lot of those of us in the press like to emphasize that ETNs come with more risk since the notes are only as good as their underlying issuer. But what about risks associated with smaller ETFs with less than $200 million in assets and low trading volumes? Isn't that a bigger concern than a global bank going under?

Should risk attributes be a defining way to classify new exchange-traded financial products?

In some circles, journalists are being blamed for not being discerning enough. The criticism is that we're buying too readily these various new labels being thrown at investors.

Are investors (and reporters) being bamboozled by Wall Street's marketing prowess again?

Comments

[DaveW]

Overall risk inherent within every investment must be considered by an investor prior to making a final decision. It is my opinion that if an ETN offers access to a desired investment niche not otherwise available by ETF or direct stock purchase, this risk is quite acceptable.
As an aside, I am waiting for the day an ETN is offered which offers access to the markets of Dubai, Qatar, United Arab Emirates, Oman & Egypt (modestly decoupled from E.U./U.S./Asia). Correct me if wrong, but only T. Rowe Price's Africa & Middle East mutual fund (TRAMX) offers this "complete" exposure.

[adan]

i agree w/ davew above: "Overall risk inherent within every investment must be considered by an investor prior to making a final decision."

one reason i avoid some etf's that cover an area that otherwise interests me, is lack of volumne