Today, there’s roughly $15 billion parked inside 196 U.S. listed exchange-traded notes, also known as ETNs. And with global banking system on the edge, ETN shareholders are smack dab in the middle of the storm.
Which ETN providers will go bust first? How can investors avoid impending disaster?
ETNs are not ETFs: While ETNs and exchange-traded funds (ETFs) are sometimes grouped together, or worse, confused as the same thing, they are not.
Unlike traditional ETFs, exchange-traded notes are debt obligations backed by the financial or banking institution that issues them. ETNs pay a return linked to the performance of a single security or index. Who pays the return? The financial issuer backing the note.
ETNs can track a variety of assets from commodities (DJP), to the VIX Index (VXX) and master limited partnerships (AMJ). ETNs are also used as day trading instruments for those that want leveraged long exposure (DGP) or leveraged short (DZZ) to gold or other assets.
Investors that choose to keep their ETN to maturity receive a cash payment, calculated from the beginning trade date to the ending period, or maturity date. The annual fees deducted reduce the value of the payment.
Maturity periods can vary and may be as long as 30 years. ETN investors that don’t want to hold their note to maturity can sell it prior to maturity on the exchange where they trade.
Faltering Credit Worthiness
In an online survey of ETFguide’s readers, 48% responded that credit ratings are not accurate, while 45% responded that credit ratings are only “somewhat accurate.”
This viewpoint concurs with mine that credit ratings are second rate. Nevertheless, they offer us a general idea about the trend in creditworthiness among ETN issuers.
Standard & Poor’s just cut the credit score for more than a dozen global banks. Other raters like Fitch Ratings and Moody’s, have negative views on banks, too, and more downgrades are ahead.
While these credit opinions still overestimate the true credit worthiness of large banks, they show the cycle of deteriorating credit quality is accelerating, not decelerating.
Would you want to lend your money to distressed borrowers on the verge of bankruptcy? What about borrowers that need to keep borrowing more and more money in order to stay afloat?
Yet, this is exactly what you do when you buy an ETN. No matter what the press releases or the CEOs say, both global (EUFN) and domestic banks (KBE) are caput without outside assistance from the Federal Reserve or ECB.