Exchange Traded Notes
Exchange Traded Notes
Exchange Traded Notes (ETNs)
ETNs resemble ETFs in that they passively track a financial index (stock, bond, commodity, foreign exchange, etc.) and trade throughout the day.
The difference is that ETNs are unsecured debt securities, whereas ETFs are a type of open-ended mutual fund. This means ETNs are backed only by the credit of the issuer—whereas in an ETF, you have a claim on the underlying assets.
However, because the ETN doesn’t have to buy the assets underlying the fund, it is possible there is no tracking error between the ETN and underlying index’s returns. The ETN (like the ETF) does charge a management fee, which means the ETN’s returns will always be lower, by the amount of this fee, than the returns it is tracking.
ETNs Are Debt Securities
But they don’t pay interest. The issuer simply promises to pay the ETN owner an amount determined by the value of the underlying index less fees at some future date—often in 30 years.
ETNs also trade throughout the day like stock and ETFs and unlike traditional bonds, though now some bonds are starting to trade on exchanges throughout the day.
ETNs issue and redeem notes throughout the trading day to keep the ETN price in line with the value of the underlying assets.
ETNs and Exotic Underlying Assets
Because an ETN is a promise to pay an underlying asset’s return and because the underlying asset doesn’t actually have to be purchased, the ETN can track returns that ETFs may have a hard time replicating. For example, consider the following ETNs:
The iPath® CBOE S&P 500 BuyWrite Index ETN which tracks an index which simulates the returns on a strategy of buying and simultaneously writing call options on the S&P 500.
The iPath® Asian & Gulf Currency Revaluation ETN which tracks a pegged currency index.
The iPath® U.S. Treasury Flattener ETN which inversely tracks the Barclays U.S. Treasury 2Y/10Y Yield Curve Index.
ETN Popularity and Growth
The next slide will show an interactive chart of the relative number of search queries for “Exchange Traded Fund” versus “Exchange Traded Note” as reported by Google Trends.
- Note that there are substantially fewer queries for ETN relative to ETF. This is not surprising given ETFs have been around longer and contain the large index funds.
ETNs & Tracking Error
While it is possible for ETNs to have no tracking error, that is not always the case. The next slide shows the ETN and underlying index cumulative returns for a random sample of iPath ETNs.
While most do a good job of tracking the index, a few (DTYL, DTYS, and PGD) do not.
This is because inverse and leveraged ETNs are meant to meet thier performanace objective (relative to an underlying index) on a daily basis.
Matching the index over a longer period is not possible given the leverage used in the ETN—which means returns will compound at a different rate between the index and the ETN.
Credits and Collaboration
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