ETNs not without risks

By Dian Vujovich

Last week, Barclays introduced a new ETN into the market place — the Barclays ETN+Shiller CAPE ETN (CAPE)—whatever that is.

As long as there are things to be traded, be they stocks, bonds, commodities, currencies or grandma’s teeth, there will always be creative product marketers who come up any variety of ways to play the let’s-make-money game. One of the relative newcomer products are Exchange Traded Notes, or ETNs.

Sounding—in acronym only– a lot like ETFs (Exchange Traded Funds) the two products are not the same. Even so, you’ll often find them lumped together while researching them which only adds to the confusion if you’d like to educate yourself  about ETNs and understand what they are.

Basically, an ETN is an unsecured debt instrument  created by financial institutions,  (Barclays brought to first ones to market),  that are supposed to provide investors the return of an index, minus taxes and fees, that’s higher than those found in the broader markets. Plus, an opportunity to hold the underlying debt security until maturity.

You don’t have to think very far back to recall the mortgage mess made by financial institutions  and the ensuring calamities we still are paying for as a result of it. And it’s that debt-related subject that brings one of the biggest risks of ETN investing to the forefront: Credit risk.

There’s much more to understanding ETNs than what was in my simple definition but staying on the simple side of things, any fixed-income related instrument is only as good as its ability to make timely interest and principle payments. Period. And, an investment product is only as good as its ability to make good on its promises. Given that holders of ETNs usually don’t receive interest payments from their investment, instead  their return is based around the underlying index on an ETNs maturity date, if an issuer goes belly up, well….that’s not so hot for the investor.

Although the ETN market is a tiny one estimated at around $16 billion—by comparison, at the end of May assets in ETFs totaled over $1.1 trillion—the risks of investing in ETNs have caught the cautious eye of FINRA.

According to a  FINRA Investor Alert: Exchange-Traded Notes—Avoid Unpleasant Surprises, the risks of ETN investing include:  credit risk; market risk; liquidity risk; price-tracking risk; holding-period risk; call, early redemption and acceleration risk; and conflict of interest risk.

For those interested in reviewing FINRA’s ENT alert, visit: http://tinyurl.com/7tv9hs8 .

Re the Barclays ETN+Shiller CAPE ETN (CAPE), according to the press release: “It will use the Shiller CAPE to find the most undervalued sectors based on the sectors’ current ratio compared to a historical average…..hoping to expose investors to the most undervalued stocks while steering clear of industries where companies may be overvalued. If the fund strategy proves successful, investors would expect total returns significantly larger than the broad market….”