The rise of exchange-traded ... notes?

Now that ETFs are a household word (at least in financial circles), market watchers are looking to structured products for the next big thing.

According to Christopher Yeagley, exchange-traded notes may be it. The managing director at Deutsche Bank says they represent "yet another significant tool for money managers and financial professionals. ETNs can actually deliver the same type of non-correlated exposure as hedge funds, with the benefit of significantly lower minimums and lower management and performance fees."

A hybrid that combines the features of ETFs and bonds, ETNs are unsecured, unsubordinated debt whose return is pegged to the performance of a market index or currency exchange rate. Similar to bonds, ETN returns are based on the performance of the underlying index and the creditworthiness of the institution issuing the note. Thus, a drop in the issuer's credit rating can cause the value of an ETN to fall, even if there is no decrease in the performance of the underlying index. And, like bonds, investors can hold the note until maturity.
Barclays Bank introduced ETNs in 2006. Now, Deutsche Bank and others will release their ETNs into retail circulation in the months ahead.

"We've only seen them really emerge in the last 6 to 12 months," says Yeagley. "We offer two of them now, but we expect to add many new ETN products in 2008."

Seen as a viable alternative to both mutual funds and ETFs, ETNs' appeal comes mainly from their lower minimums, lower fees, transparency and liquidity. ETNs, like ETFs and unlike mutual funds, trade on an open exchange, which allows investors to move quickly.

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