After a stunning 60% decline in a VIX ETN (TVIX) sponsored by Credit Suisse, another ETN has taken a nosedive. This time it’s the iPath DJ-UBS Natural Gas ETN (GAZ), which has declined more than 55% in value since its March 19 closing price of $6.02.
This latest episode is casting new doubts about the reliability of ETNs in obtaining market accurate exposure to stocks, bonds and commodities. GAZ was designed to closely follow natural-gas futures contracts, but it has been way off course.
Although GAZ, a Barclays product, now trades at a 63% premium to its underlying assets, it once traded at 134% premium to the value of its natural gas benchmark.
What’s going on?
In August 2009, Barclays stopped issuing new GAZ shares, which the company acknowledged could cause the ETN to trade at a premium or discount in relation to the note’s indicative value. As a result, GAZ shares began to trade higher in value, far above their indicative value.
These distortions in an ETN’s share price from the value of its underlying assets is a serious product flaw that has long plagued closed-end mutual funds. These flaws are compounded for ETNs that use 2x and 3x daily leverage.
Premiums and discounts can also occur with ETFs, but are typically smaller and less frequent, especially for heavily traded ETFs and funds that avoid futures contracts to get the bulk of their market exposure.