ETF, known as Exchange-traded funds, and ETN, also referred to as exchange-traded notes are different types of Exchange-traded products. ETF have a history dating back to 1993, and they did enjoy widespread popularity among investors since birth. While exchange-traded notes (ETNs) may sound somewhat similar in name, it's crucial to recognize that ETNs differ significantly from ETFs and come with their own set of noteworthy risks.
An ETF is a container for a collection of various securities, including stocks, bonds, or commodities. It shares numerous similarities with mutual funds, but compared with mutual funds, an ETF can be traded on an exchange just like individual stocks. A crucial aspect of both ETFs and mutual funds is their legal separation from the managing company. This distinction is important for investors because even in the event that the ETF managing company ceases its operations such as going bankrupt etc, the assets within the ETF such as stocks remain entirely separate. This can ensure that investors still retain ownership of the fund's underlying assets even if the managing company does not exist anymore.
On the other hand, the ETN operates differently. Although an ETN still contains a collection of securities and it also tracks the same index as an ETF, the ETN takes the form of a bond issued by a financial institution. This institution commits to providing ETN holders with the returns linked to a specific index over a designated time frame. The institution will refund the initial investment when ETN matures. However, if the company issuing the ETN is facing bankruptcy, ETN holders could be left with nothing. So, ETN is actually an investment in debt, similar to a company bond. It's an unsecured debt note issued by a bank or a financial institution. Also, from the payment perspective of the funds, An ETN provides investors with a payout when the fund reaches its maturity, and this payout is determined by the price of the underlying asset or index. ETNs do not pay any interest payments to investors. In comparison, bonds will pay investors periodic interest payments along the way.
Considering that ETNs naturally carry some credit risks, you may question why investors still choose to use them. Actually, there are several appealing features which make ETNs an attractive option for some investors.
One of the most significant features in ETN is that it usually has no tracking errors from the index because the issuer commits to providing the exact return on an index. Tracking errors indicate the gap between the real index and the actual return of an investment product. Except for some well-managed ETFs, most ETF products have tracking errors. In comparison, you can expect an ETN to closely mirror the performance of the index it's linked to. Also, certain ETN offer access to returns from a unique index in a specific niche which is not covered by an ETF. This is especially important for investors interested in such niche investments because ETN might be the sole option. Moreover, ETNs can present some tax advantages to long-term investors. ETN investors typically incur taxes on their investment only when they sell it at a profit or when the ETN reaches maturity. Unlike stock or bond funds, ETNs don't disburse dividend or interest income, so most taxes are deferred and treated as capital gains.
