Exchange-traded notes (ETNs) are popular debt securities whose return is linked to a market index or other financial instrument(s). Though ETNs are popular due to their convenience and apparent cost-effectiveness, ETNs also carry substantial risk and are more complex than meets the eye.
ETNs are unsecured debt obligations, but are distinct from traditional bonds in that ETNs do not typically pay interest: Instead, ETN issuers (such as banks or financial institutions) promise to pay investors a specified amount of money, called a distribution, which is associated with the performance of the aforementioned market index/financial property, minus incidental or predefined fees.
Leveraged ETNs specifically pay a multiple of the performance of the aforementioned propery (e.g., three times the market index performance, or $3 for every $1 of performance). Meanwhile, inverse ETNs pay the opposite of the property's performance (e.g., $1 profit for every $1 the market loses). The two types of ETNs may furthermore be combined in a leveraged inverse ETN, which pays a multiple opposite of the property's performance (e.g., $3 for every $1 the market loses).
Because of its dependence on market performance as opposed to interest payments, an ETN is additionally risky and leveraged ETNs even moreso. One or two bad market days can shred an investor's holdings in a leveraged ETN.
All three ETNs—leveraged, inverse and leveraged inverse—may reset their exposure daily while others may "reset" weekly, monthly or even yearly. These resets can "de-couple" actual performance of invested dollars compared to the stated return of the linked index or instrument. ETNs which reset their holdings daily are designed for intra-day trading and are not designed to be held overnight. Many brokers and brokerage firms miss this critical distinction to their clients' detriment.
In addition, there is also issuer risk, the risk that the company issuing the ETN defaults on its payments. If this occurs, investors may lose some or even all of their investment.
As with any investment, these risks are real and require thorough research into the true nature of ETN investment. Whether via the specific ETN's prospectus or using the SEC's EDGAR database, it is imperative that investors determine the specific properties of an ETN before choosing to invest.
If you believe you have been misled by a firm, ETN issuer, broker or advisor and this has proven harmful to your investment or interests, please call The Law Offices of Jonathan W. Evans & Associates at (800) 699-1881 for an investigation and consultation.
Investor Alert: Exchange-Traded Notes—Avoid Unpleasant Surprises