ETF or ETN?

Deutsche Bank has been in the news recently with questions about its financial integrity. Many investors are probably not paying much attention unless they own the stock. However, no attention is being focused on the investors who own DB’s ETN’s? This is important and here is why.

When you consider where to invest your money, you and many other investors might be wondering what’s better: exchange traded funds (ETFs) or exchange traded notes (ETNs) or both?

When you are constructing your portfolio, it is a good idea to research both products. They both have good diversification aspects and offer benefits that are exclusive to their genre.

There are differences between ETFs and ETNs that may help you in the decision-making process. Neither type of investment is inherently good or bad – they both offer benefits. It all depends on what your goals are and what your comfort level happens to be:

  • ETFs have the liquidity that comes with a single stock. ETNs are a debt obligation, so credit risk is a concern investors need to be mindful of.
  • ETFs offer instant diversification because when you purchase one, you invest in a fund that buys and holds multiple assets. This includes equities, bonds, and commodities. ETNs are not investments in funds; instead, you are buying debt from the issuer and they are backed by the full faith and credit of the issuer.
  • ETNs have maturity dates. When you hold an ETN until the maturity date, you receive a one-time payment based on the performance of the underlying asset, index or strategy. If you wish to sell sooner, you can sell on the open market.
  • When you buy an ETF, you buy ownership of a basket and its contents, not piecemeal ownership of the individual contents. The savings come from trading costs and initial capital that you would need to invest in single stocks.
  • The tax treatment of ETFs and ETNs is different. With ETNs, you are taxed only upon sale. Short-term capital gains rates apply if held for less than one year; long-term capital gains rates apply if held for more than one year. As for ETFs, they could be a little trickier, especially when it comes to commodity ETFs that hold futures and leveraged funds. Doing homework on this is necessary.
  • Both ETFs and ETNs give access to hard-to-reach markets, such as currencies and certain foreign markets. One example of the benefits of ETNs is the iPath MSCI India ETN (INP), which gave investors the ability to gain exposure to a rapidly growing economy before the India ETFs came along.
  • ETNs have no tracking error; this can be very attractive to some investors. However, tracking error has not been a terribly big problem with ETFs.

When it comes to ETFs vs. ETNs, it comes down to tax treatment and credit risk. Step back, assess your priorities and what level of risk you’re comfortable with.

Investors should learn from history and remember, history can repeat itself. So, with that said, ETN investors should re-evaluate whether they want to continue owning DB’s ETN’s as well. Deutsche Bank had several credit rating downgrades over the past month. So, there is a perceived heightened credit risk from the rating agency’s perspective. Lehman Brothers had several ETN’s and went through a similar situation years back. This does not mean Deutsche Bank is going to fail. It means investors should pause here, look at the risks and evaluate for themselves.

 

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