On December 1, 2015, the SEC’s Office of Investor Education and Advocacy issued an investor bulletin to educate investors about exchange-traded notes (ETNs).5 In particular, the bulletin explains how ETNs differ from exchange-traded funds (ETFs) and certain risk factors that are associated with an investment in ETNs.
The investor bulletin highlighted some of the differences between ETNs and ETFs, noting that there is some investor confusion in distinguishing the two:
- ETFs are registered investment companies. As such, an investor in an ETF has ownership interest in an underlying portfolio of assets.
- Unlike ETFs, ETNs do not own an underlying portfolio of assets, which makes holders of ETNs subject to the creditworthiness of the issuer itself.
- ETFs issue and redeem their shares in creation units at their net asset value.
- Rather than using net asset value, ETN issuers calculate the value of the ETN using a described formula.
The investor bulletin provides a list of potential risks to consider before investing in ETNs. Those risks include:
- The complexity of ETNs and their fees, which are included in either the reference asset or the calculation of the value of the ETN.
- Credit risk – Investors in ETNs are subject to the creditworthiness of the issuer and would be creditors if the issuer defaults on payments.
- Leveraged, inverse, or inverse-leveraged ETNs reset their exposure to the exposure level stated in the prospectus on a daily basis, which means that all investors receive an equal amount of leveraged, inverse, or inverse-leveraged exposure.
- Investors holding such ETNs for more than one day should not expect to receive returns proportional to the exposure stated in the prospectus, and the difference could be significant.
- Leveraged, inverse, or inverse-leveraged ETNs should not be used as buy-and-hold investments.
This investor bulletin is one of several regulatory pronouncements regarding ETNs over the last several years. The investor bulletin is quite similar to the Financial Industry Regulatory Authority, Inc.’s Investor Alert “Exchange Traded Notes—Avoid Unpleasant Surprises,” issued in July 2012.6 The SEC’s Division of Corporation Finance sent a sweep letter to several ETN issuers in February 2014, and the Division of Market Regulation published a request for comment on exchange-traded products, including ETNs, in June 2015.7