INCLINE VILLAGE, Nev. and#8212; Weand#8217;ve heard and known that when it comes to investing risk and reward go hand in hand. And itand#8217;s always been true ... until now.
Case in point, Exchange-traded notes (ETNs), which are sponsored by a handful of banks and brokers. Even though some banks have been downgraded, investors in their ETNs are receiving nothing for the added risk. Barclays was in the news last week when the Chairman and CEO both resigned amid a LIBOR rate-fixing scandal and the bank settled by paying a $450 million fine.
But investors in their ETNs are receiving nothing more in return for the added risk now inherent in Barclays-sponsored ETNs. Thatand#8217;s not right. Iand#8217;ll explain.
ETNs look and feel like ETFs, so many investors assume they are the same. ETNs trade like ETFs and allow individual investors to buy difficult-to-reach market segments, such as commodities, but they are not the same. ETFs are backed by their portfolio holdings (i.e., investors would be made whole by their claims on the stocks held by the ETF), but ETNs are only backed by the issuing bank or broker, so they are only as good as their sponsor. Itand#8217;s a bond-like structure.
The advantage of ETNs is that their returns match their target index. There is no tracking error. Good. But is it worth bearing more credit risk? I think not.
Iand#8217;m not predicting that an ETN sponsor will go belly-up, thatand#8217;s very unlikely. It is a possibility, however, and ETN holders should be aware. In February 2008, Lehman Brothers introduced several ETNs under the Opta brand name. When Lehman closed its doors, so did its ETNs. Shareholders joined the long line of Lehman creditors.
Before buying an exchange traded product, especially if it tracks a commodity, one should know if it is an ETF or an ETN. Although they appear the same, an ETN is only as strong as its sponsor. In my view, investors arenand#8217;t being compensated for the added risk.
and#8212; David Vomund is an Incline Village-based fee-only money manager. Information is found at www.ETFportfolios.net or by calling 775-832-8555. Clients hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial advisor before purchasing any security.