Beware ETNs

Sep.17.08 | About: Market Vectors (CNY)

The Chinese renminbi is one of the most stable currencies in the world. Its value against the dollar is severely constrained by the Chinese government, and it never moves very far in any given day. But, it's hard for foreigners to invest in. So instead they tend to buy things like CNY (NYSEARCA:CNY), an exchange-traded note designed to mirror the performance of the renminbi.

But just look at how that's been behaving today: certainly not like a stable currency. It opened at $36.49; less than two hours later it was down more than 24% at $29.37. Why? Just take one look at the fund's home page:

Market Vectors Currency Exchange Traded Notes are senior, unsecured debt securities issued by Morgan Stanley that deliver exposure to the exchange rate of foreign currencies.

Oh. Right.

As my correspondent G P says,

Perhaps this might be a good time for a story to remind your readers about the difference between an ETN and ETF: an ETN is just a pre-paid forward contract, a form of debt security. There is no underlying basket of assets, unlike mutual funds or ETFs. Some CNY holders might imagine that they, in effect, hold cash in a renminbi-denominated bank account, which is not the case.

There's risk in ETFs, too, actually. Many ETFs tracking indices or commodities do so by means of derivatives contracts rather than solely through owning the underlying asset. The ability to use derivatives in such a manner is far from assured; it's surely harder today than it normally is. So remember, if you're buying or selling ETFs right now, they might behave rather more wackily than usual.