An increasing number of exchange traded notes (ETNs) can be purchased from stockbrokers on investment and ETF platforms.
They are similar to exchange traded funds, but you should be aware that there are some important differences and risks.
An ETF invests directly in the underlying shares, bonds, other securities or commodities it is tracking. These are held by the independent custodian or trustee appointed by the ETF provider.
An ETN, however, can offer you access to the returns offered by a basket of securities or commodities without even investing in those securities or commodities.
An ETN is a note – typically issued by a bank - in which the issuer promises to pay you the returns you would get if you invested in a basket of securities or a commodity.
It is unsecured debt, so there is a risk that the issuer could default on its promise to pay. This is why ETNs introduce what is referred to as credit risk, although it is relatively low if the note is issued by a big bank with a strong balance sheet as is the case with all JSE-listed ETNs.
The banks issue ETNs to give you access to indices in markets that are less than liquid – like African stock markets - or to commodities such as oil or wheat.
Use of derivatives
In order to give you the promised return, the bank may invest in derivatives that will deliver the performance equal to that of an index or commodity.
Because ETNs tracking indices do not actually invest in those indices, they do not distribute dividends. They only promise to pay you out what you would have earned in dividends plus any gain on the prices of the shares in the index when you disinvest.
Another key difference in the case of some ETNs is that the investments may not be diversified. An ETN tracking the price of copper or silver, for example, will rise and fall with the price of that commodity.
ETNs are not collective investment schemes subject to the regulation of the Collective Investment Schemes Control Act.
