While most traders are familiar with exchange traded funds, or ETFs, many arent as familiar with another common exchange traded product: the exchange traded note (ETN).
ETFs are funds that actually invest in the assets they track, such as stocks bonds or commodities. ETNs, on the other hand, are unsecured debt notes issued by financial institutions. In other words, ETFs are more similar to stocks, while ETNs are more similar to bonds.
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Because the bond-like characteristics of ETNs, investors need to pay close attention to the default risk of ETN underwriters. ETNs trade not only in relation to the assets they are intended to track, but also potentially in relation to the credit risk associated with their underwriters.
Since ETNs dont actually buy and sell assets, they theoretically dont suffer from tracking errors as much as ETFs do. The costs associated with buying and selling assets typically cause ETFs to underperform their benchmark over time.
Many times, investors can choose whether they want to invest in an asset via an ETF or an ETN. For example, the most popular WTI crude oil-tracking ETF is the United States Oil Fund LP (ETF) (NYSE:USO). However, the iPath S&P GSCI Crude Oil Total Return (NYSE:OIL) ETN is also designed to track WTI prices. The OIL ETN is backed by the credit of Barclays (ADR) (NYSE:BCS).
On the surface, ETFs and ETNs trade in a nearly identical manner. However, long-term investors should be aware of the differences between the two instruments and what the implications of those differences could be.
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