Market Pulse: Know the risks (opinion)
Since the March 2009 financial crisis low, Bank of America is up 800 percent, JPMorgan Chase & Co. is up 600 percent, and Deutsche Bank is down 35 percent. What is going on with Deutsche Bank? Maybe investors might be at more risk than they realize. Let me explain.
Most everyone has heard of or own exchange-traded funds (ETFs). The cousin of an ETF is an exchange-traded note (ETN). Although investors may not notice the difference, ETNs are not the same as ETFs and with about 1800 exchange-traded products it’s important to know what you own.
Both ETFs and ETNs trade throughout the day and give investors easy access to segments of the market. Whereas ETFs typically track equities, both here and abroad, ETNs often track commodities and futures markets. They give the common investor easy access to difficult-to-reach markets.
The difference: While ETFs are backed by a portfolio of securities, ETNs are backed by the financial strength of the issuer, typically a bank. If the bank gets into financial trouble, the ETN would suffer (think Lehman).
The financial stability of ETNs is only as good as the credit condition of the issuing bank. For that reason, ETNs don’t share the popularity of ETFs.
Now back to Deutsche Bank. With about 25 ETNs, Deutsche Bank is a big issuer. Most of their ETNs track commodities, such as Gold Double Long (DGP) or Gold Short (DGZ). Some others, like Elements Dogs of the Dow ETN (DOD), track equities.
Keep in mind these ETNs are not secured by the gold or the equities that they track. Instead they are secured by the bank’s credit status so these ETNs hinge on the bank’s ability to meet its financial obligations.
I should note that when you buy a commodity index ETF or ETN, be sure you understand what it tracks. An oil fund, for example, can track energy stocks, nearest-month oil futures contracts, or futures contracts with other expirations. Performance will vary depending on its structure.
I’ve picked on Deutsche Bank, but they aren’t alone in their struggles. The recapitalization of European banks has been at glacial speed compared to U.S. banks. We had TARP, they didn’t.
As a result, ETNs from some European banks should have a higher risk premium. Know the risks before you buy.
David Vomund is an Incline Village-based fee-only money manager. Information is found at http://www.VomundInvestments.com 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.