Earlier this month we took a look at FINRA’s 6 Critical Tips Before Buying ETNs—unsecured debt obligations of the issuer, such as a bank or other financial institution.
The Financial Industry Regulatory Authority wants to make sure that investors are aware of the differences between exchange-traded notes and other, perhaps more traditional, investments—lest they be taken unaware and get in over their heads. To that end, it has issued an investor alert to educate people about their benefits and pitfalls.
This week we’re checking out, courtesy of that investor alert, some specific risks investors should beware of if they’ve done at least some homework and decided to invest in ETNs anyway.
1. Risky Business: Credit Risk
Have another look at that definition of an ETN—it’s an unsecured debt obligation. So if the issuer defaults, the investment goes bust. If you’re going to sink money into one of these, make sure you can afford to lose it—all of it. 2. To Market, to Market, to Buy a Fat Pig—Oh, Wait; Pork Is Down: Market Risk
The value of an ETN is tied to its index. If the market becomes disillusioned with that index, the ETN’s value can plummet and take the investor’s principal with it—putting the investor in the hole in more ways than if she just put her money into an investment only subject to credit risk.
Another factor to consider is what the index being tracked by the ETN is measuring. Is it a dynamic trading strategy? A futures market? And does it reflect total returns, or some other criterion? 3. Flow Gently, Sweet ETN: Liquidity Risk
Be wary if you have to keep investment funds liquid. An ETN can tie up funds if a trading market fails to develop. Not only that, but there are times when an issuer can simply delist an ETN—in which case, nobody will be buying or selling anything. Including you. 4. Follow the Money: Price-Tracking Risk