Exchange-traded notes (ETNs) can be tricky, convoluted investments – and one that often spells a financial nightmare for the novice investor.
By definition, an ETN is an unsecured debt security in which the issuer – typically a bank or another financial institution – promises to pay a distribution based on terms laid out in the ETN’s prospectus. But, as many ETN investors discover, those terms can be highly complex.
ETNs are usually linked to indexes tracking commodities, foreign currencies, stocks, emerging markets, volatility, or other benchmarks selected by the issuer. Much like stocks or exchange-traded funds (ETFs), ETNs are traded throughout the market day. Finally, although investors may come across materials that reference ETNs as shares, they are, in fact, unsecured debt obligations.
The Financial Industry Regulatory Authority (FINRA) recently issued an Investor Alert on ETNs. Among other things, FINRA warned investors about some of the dangers associated with products. They can be illiquid, subject to early redemption at the issuer’s discretion, trade at a higher price than their underlying index, and contain conflicts of interests, FINRA says.
The conflict of interest warning poses particular concern for novice investors. That’s because the bank responsible for issuing shares of the ETN could very well be betting that it moves in the opposite direction of your ETN.
The bottom line: When it comes to investing in ETNs, proceed with caution. While not all ETNs are bad investments, of course, it’s what you don’t know that can hurt financially. Beyond their inherent complexity, ETNs are market-linked products. That means the value of the ETN is largely influenced by the value of the index it tracks. As the value of the index changes with market forces, so too will the value of the ETN. And that can result in a loss of principal to investors.