With over $1 trillion in assets, investors are betting with their wallets that exchange traded funds (or ETFs) are an excellent investing vehicle. Basically, exchange traded funds are baskets of investments – which range from stocks, bonds and even commodities.
But there is confusion about how ETF funds differ from ETN investments. ETN stands for exchange traded note, rather than exchange traded fund.
For the most part, an ETF is based on an index like the S&P 500 or Thomson Reuters/Jefferies CRB Index. Because of this, the fees tend to be low and so is the portfolio turnover. The result is that the tax hit is usually lower (in terms of capital gains distributions). Another nice feature is that you can buy and sell an ETF fund throughout the trading day. In fact, it is even possible to borrow against the securities and short them (which means making money when the value of the investment falls).
ETN investment is similar to ETF investment in terms of daily trading, borrowing against the assets and tracking indexes. However, there are some big differences. For example, an ETN is an unsecured debt of a financial institutions. So think of it as a loan in exchange for a basket of investments – not a fund of component stocks or assets.
This is important since an ETN will typically track an index more accurately than an ETF. There is also a nice tax advantage, in which there is no capital gains distributions until the sale of the ETN.
OK, so what is the hitch? Well, since an ETN is a loan, there is a possibility that you may not get your investment back if the financial institution fails. This is why it is a good idea to focus on ETNs of large companies, with strong long-term track records (although, as seen with Bear Stearns and Lehman Brothers, this is not easy to know).
Interestingly enough, ETN investments are getting more popular. According to ETF Trends, there are 135 U.S. listed ETN flavors, which have nearly $16 billion in assets.
Let’s take a look at 5 of the largest ETN investments out there:
iPath S&P GSCI Crude Oil TR Index ETN (OIL)
The iPath S&P GSCI Crude Oil TR Index ETN (NYSE: OIL) tracks the price of light, sweet crude oil. This is done by purchasing futures contracts, which allow for the delivery of the commodity at a later date.
Unfortunately, in some cases, the markets may go into contango – which means the current price is lower than the futures prices – and this can mean that an ETN can lag. But as for the iPath crude oil ETN, it has tracked the spike in oil fairly well. The price of the security has gone from $23.23 in mid February to $27.81.