Understanding ETNs

Exchange-traded notes (ETNs) are complex products that combine elements of both bonds and ETFs. 

ETNs are a type of unsecured debt security, they are not backed by collateral and trade on stock exchanges, similar to ETFs and equities. 

However, ETNs do not pay periodic interest unlike bonds and are designed instead to track an underlying index. 

Issuer and investor dynamics

Banks such as Barclays typically issue ETNs and decide factors including a product’s return rates and the maturity date. 

Having an ETN does not mean investors have ownership of the underlying securities – unlike a physical ETF – however, they are paid the return of the index. 

In other words, when an investor purchases an ETN, they are essentially buying a debt instrument issued by the issuer and the return on investment is linked to the performance of an index. 

This underlying debt instrument can range from commodities including gold or silver to stock indices, currencies or even more complex strategies. 

ETNs were particularly popular when investors were unable to access certain exposures through other vehicles such as ETFs or exchange-traded commodities (ETCs). 

The ETN market has developed in recent years to include products that are fully collateralised including crypto ETNs such as the VanEck Bitcoin ETN (VBTC) which tracks the MarketVector Bitcoin VWAP Close index and is 100% backed by bitcoin. 

Benefits and risks

One benefit of ETNs is issuers guarantee to pay exactly the return of the index minus fees which means they do not suffer from tracking error. This is unlike physical ETFs which are required to own the underlying holdings. 

However, investors in ETNs face credit risk as they rely on the creditworthiness of the issuer. If the issuer defaults, an ETN investor will likely lose their entire investment. 

Market evolution and considerations

Furthermore, many ETNs have low trading volumes which can lead to wide bid-ask spreads for investors, especially given the issuer has control over the creation-redemption process. 

For example, an issuer may halt primary market creations of its ETN, a move that can drive significant premiums to net asset value (NAV). If the issuer resumes creations, this can lead to a sharp fall in the ETN’s price. 

Final word

There are inherent credit and liquidity risks with ETNs that investors must be aware of. While ETNs also fall under the exchange-traded product (ETP) universe, they are very different to ETFs and can easily lead to negative outcomes for investors.