Tahoe Market Pulse: The difference between ETNs and ETFs
The growth of exchange-traded funds (ETFs) has been nothing short of phenomenal. Over the past 10 years, ETF assets have grown by 600 percent and the number of funds has soared 700 percent.
The same can’t be said of their cousin, exchange-traded notes (ETNs). Although investors might not notice the difference, ETNs are not the same as ETFs. Know the difference.
ETNs look and behave just like ETFs. Both trade throughout the day and give investors easy access to segments of the market. Whereas ETFs typically track equities, both here and abroad, ETNs often track commodities and futures markets.
They give the common investor easy access to difficult-to-reach markets. Because most ETNs are tied to commodities, the recent bear market has been a drag on their assets. But prices for most commodities, oil in particular, are now rising. Investors may take note.
The largest ETN is iPath Bloomberg Commodity Index Total Return (DJP). A popular ETN for traders is the iPath S&P 500 VIX Short-Term Futures (VXX). Several of the largest ETNs track Master Limited Partnership indexes.
Now the difference: While ETFs are backed by a portfolio of securities, ETNs are backed by the financial strength of the issuer, typically a bank. If the bank gets into financial trouble, the ETN would suffer (think Lehman).
For that reason, ETNs don’t share the popularity of ETFs. The market value of ETNs is $20.8 billion compared to $2.1 trillion for ETFs and just as many ETNs are closing as opening.
As part of their efforts to make big banks more financially secure, the Federal Reserve is proposing to limit certain liabilities, including ETNs, to 5 percent of a bank’s total liabilities. That may put a damper on future ETN issuance.
When it comes to buying a commodity index ETF or ETN, be sure that you understand what it tracks.
An oil fund, for example, can track energy stocks, nearest-month oil futures contracts, or futures contracts with other expirations. Performance will vary depending on its structure.
David Vomund is an Incline Village-based fee-only money manager. Information is found at http://www.VomundInvestments.com or by calling 775-832-8555. Clients hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.
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