Exchange Traded Notes or “ETNs” are unsecured debt obligations typically issued by financial institutions. They differ from traditional bonds because unlike bonds, ETNs don’t pay any interest to investors. The issuer instead undertakes to pay the holder of the ETN at maturity (which can be 10, 30, or even 40 years after issuance) a “distribution” to be determined by the performance of an underlying index or benchmark. ETNs also differ from traditional bonds in that ETNs trade on exchanges in the same fashion as stocks and ETFs. Their prices in the market fluctuate throughout the day. But unlike ETFs, ETNs don’t buy or hold any assets to approximate the performance of the underlying index.
Exchange Traded Notes often are sold to investors for whom they are entirely unsuitable. Several days ago, FINRA sought to inform investors of the features and risks of ETNs by issuing an Investor Alert entitled Exchange Traded Notes – Avoid Unpleasant Surprises. FINRA’s Vice President for Investor Education stated, “ETNs are complex products and can carry a raft of risks. Investors considering ETNs should only invest if they are confident the ETN can help them meet their investment objectives and they fully understand and are comfortable with the risks.”
FINRA’s alert warns about a host of other concerns. For instance, it noted that some of the indices and strategies used with Exchange Traded Notes can be very sophisticated and may not have much performance history. It also explained that unless held to maturity, the return on an ETN will generally depends on price changes in the fluctuating market and this can result in a loss of principal to investors. Ownership of ETNs also involves credit risk because the investment consists of unsecured debt of the issuer. It also presents liquidity risk since, even though an ETN is designed to trade on an exchange, the envisioned trading market may never develop. And ETNs carry price-tracking risk in that an ETN’s market price can deviate, sometimes significantly, from its actual value.
FINRA also warned about a particularly risky species of Exchange Traded Note – namely, leveraged and inverse Exchange Traded Notes. These are designed to track some multiple of an underlying index or to perform in a manner opposite that of the index. They reset their market exposure daily, and thus are day trading tools unsuited for mid-range or long term investing. If held longer than a day or two, they tend to produce nasty surprises. In fact, they can even move in the opposite direction from their stated objective.
If you want to learn more about the hazards of owning exchange-traded notes, check out the FINRA alert here.
And if you’ve lost money in an Exchange Traded Note that you didn’t really understand or that you now suspect was unsuitable for you, don’t hesitate to call us. Contact Hugh Berkson at (866) 932-1295, or reach us through the consultation form on the right of this page. We’ve helped hundreds of aggrieved investors. Talk to us about how we can help you.