What is an ETN?

Portfolio diversification can minimize your risk and increase your potential returns. Some investors analyze stocks and make individual picks, while others prefer to invest in assets that provide instant diversification. Exchange-traded notes (ETNs) can provide the diversification you need and potentially increase your portfolio’s returns.

How Does an Exchange Traded Note Work?

ETNs are unsecured debt securities that give investors exposure to the performance of a market index or benchmark. When the debt matures, you receive the full value of the index. For instance, if you bought an ETN following the S&P 500 for $10,000, and the S&P 500 had a 20% net gain on the ETN’s maturity date, you would receive $12,000. However, if the S&P 500 lost 10% of its value by the time the ETN matures, you would only receive $9,000. 

You could also buy an exchange-traded fund (ETF) that mirrors the S&P 500, but ETNS offer several advantages and have key differences from ETFs. 

Understanding the Structure of an ETN

ETNs are debt instruments that do not give investors ownership over the assets. Investors still benefit from the appreciation of the ETN’s index or benchmark. Since the financial institutions issuing ETNs do not own the assets, they can save money on fees and make commodities and currencies more accessible to investors. ETNs have maturity dates where investors receive the full value of the index. ETNs do not pay interest leading up to the maturity date. 

Understanding the Tax Implications of ETNs

ETN investors enjoy tax advantages over investors who buy ETFs. Since ETNs do not give investors ownership of assets, they do not receive dividends or interest payments. Not receiving those payments can reduce your short-term capital gains and ordinary income taxes. Some ETFs sell securities and generate short-term capital gains, which increase your taxes. ETN investors do not have to worry about that scenario.

ETN investors only pay taxes on gains that are generated at maturity. If you hold onto your ETN for over a year, you pay long-term capital gains taxes on your profits. Paying the long-term capital gains tax rate can help you save money on taxes. It is a good idea to consult a tax professional to discuss your options and how ETNs can affect your tax bill before getting started.

Examples of Popular ETNs

ETNs give investors exposure to various commodities and other assets that are more difficult for financial institutions to hold without incurring high fees. Oil, gold and currencies are some ETN holdings. These assets can also give you exposure to sectors like technology and healthcare. 

ETNs give you exposure to these assets even if you or the financial institution do not own the asset. Financial institutions look at how the index performed and pay the index’s full value at maturity. The ETN can do other things with your money to generate a return while waiting for the ETN to mature. These are some of the most popular ETNs:

• JPMorgan Alerian MLP Index ETN (AMJ)
• ETRACS Alerian Midstream Energy Index ETN (AMNA)
• iPath Series B Bloomberg Cotton Subindex Total Return ETN (BAL)
• MicroSectors FANG & Innovation ~3X Leveraged ETN (BULZ)
• DB Gold Double Long ETN (DGP)

Advantages of Investing in ETNs

Investing in ETNs offers several advantages for investors. These are some of the perks you can expect:

• Portfolio diversification: ETNs give investors exposure to indexes and benchmarks that hold several assets.
• Assess to commodities: Commodities are more difficult for investors to access, but you can get exposure to them with ETNs.
• Ease of trading: ETNs are accessible and are easy to trade on stock exchanges.
• Liquidity: You can sell your shares before the ETN reaches its maturity date.
• Save on taxes: You won’t have to worry about short-term capital gains and distributions getting taxed. 

Disadvantages of Investing in ETNs

ETNs offer several advantages, but just like any investment, they have their weaknesses. Here are some of the things to keep in mind before investing in an ETN. 

• Credit risk: The investment bank has to stay solvent for you to receive the ETN payout at maturity. It’s important to check if the financial institution issuing the ETN is financially secure.
• Focusing on one sector: While ETNs give you exposure to the performance of several assets, some ETNs only focus on one sector. You can have exposure to various tech stocks, but a portfolio that only has tech stocks isn’t diversified. 
• No dividend or interest payments: While not receiving these payments will help out with taxes, some investors prefer receiving cash flow. Those payments can help cover living expenses or get reinvested, but ETNs do not have dividend and interest payments.

ETF vs. ETN

ETFs and ETNs give you exposure to similar opportunities. You can get exposure to a collection of stocks and other assets based on a specific sector. ETNs give you more versatility, as you can get exposure to commodities and currencies. ETNs also let you avoid short-term capital gains and distributions, which can trigger taxes.

However, ETFs give investors ownership of shares. ETF investors can wait for their capital to grow over time and can navigate volatility. However, ETN investors have to keep the maturity date in mind. ETN investors will also have to incur long-term capital gains when the debt security matures. ETF investors can defer long-term capital gains by holding onto their shares. Deferring long-term capital gains gives ETF investors a wider range of strategies. These investors can wait until retirement to sell shares to save money on taxes. They can also sell profitable ETFs alongside unprofitable investments to minimize capital gains.

Diversifying Your Portfolio with ETNs

ETNs give investors extra diversification and give them access to assets normally inaccessible to retail investors. These assets are similar to ETFs but do not give you ownership of shares. You can benefit if the underlying benchmark or index appreciates. You should assess your financial goals and portfolio concentrations before considering ETNs.

Frequently Asked Questions