Friday, May 9, 2008

ETNs vs. ETFs

Today's RoB article about the launch of U.S. Platinum Exchange Traded Notes (ETN's) mentioned an interesting point on a key difference between Exchange Traded Funds (ETF's) and ETN's:

Investment bank UBS launched two ETNs offering long and short trading strategies in platinum. ETNs, unlike exchange-traded funds, do not purchase physical platinum to back the number of shares sold.

Investopia defines an ETF as
A security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange, thus experiencing price changes throughout the day as it is bought and sold.

Because it trades like a stock whose price fluctuates daily, an ETF does not have its net asset value (NAV) calculated every day like a mutual fund does.

By owning an ETF, you get the diversification of an index fund as well as the ability to sell short, buy on margin and purchase as little as one share. Another advantage is that the expense ratios for most ETFs are lower than those of the average mutual fund. When buying and selling ETFs, you have to pay the same commission to your broker that you'd pay on any regular order.

while it says that an ETN is
A type of unsecured, unsubordinated debt security that was first issued by Barclays Bank PLC. This type of debt security differs from other types of bonds and notes because ETN returns are based upon the performance of a market index minus applicable fees, no period coupon payments are distributed and no principal protections exists.

The purpose of ETNs is to create a type of security that combines both the aspects of bonds and exchange traded funds (ETF). Similar to ETFs, ETNs are traded on a major exchange (ie. NYSE) during normal trading hours. However, investors can also hold the debt security until maturity. At that time the issuer will give the investor a cash amount that would be equal to principal amount (subject to the day's index factor).

One factor that affects the ETN's value is the credit rating of the issuer. So, the value of the ETN may drop despite no change in the underlying index, instead due to a downgrade in the issuer's credit rating.

It should also be noted that structures like the Central Gold Trust and the Central Fund of Canada physically hold bullion.

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