ETNs – Advantages and Disadvantages : NobleTrading Blog

Friday, September 19, 2008

ETNs – Advantages and Disadvantages

Exchange trading notes or ETNs are one of the newest products available for investing and trading, and offer many advantages and disadvantages to investors/traders.

Advantages of Exchange Traded Notes

They are traded on exchanges, and like ETFs, can be shorted.
No tracking error – Exchange traded notes offer returns which are exact replica of underlying index, minus any fees involved.
They are issued by large financial institutions, like big international banks.
They offer tax efficiency – ETNs are treated as prepaid contracts, as there is no taxable incomes like dividends or interest rate payments with ETNs.
Liquid products – as ETNs are structured to resemble ETFs, they are liquid; investors can buy and sell them in normal trading hours and institutional redemption is available on a weekly basis.

Disadvantages of Exchange Traded Notes

Counterparty risk in addition to market risk. Return from ETNs greatly depends on the issuer’s capability of repay to investors.
Illiquidity in trading the product – As there are not much performance history available, many investors are hesitant to trade ETNs. The illiquidity increases as only weekly redemption is available for institutional investors; compared to daily redemption of ETFs.
The tax benefits may fade away in future as IRS is yet to decide exact tax treatment.
Expenses and commissions – Although costs involved ETNs are as cheaper as ETFs, the investor may get a little/no profit when the market is not performing to the expectations.