Investors might use the terms exchange-traded fund and exchange-traded note interchangeably, but there’s a significant difference in the products’ structures. Owners of ETNs issued by
Credit Suisse Group
or other troubled banks may ultimately learn that lesson the hard way.
While ETFs own securities directly, ETNs—a niche investment vehicle that has been seeing growing assets—are unsecured debt products created by a financial institution, usually a bank. There is no portfolio, just a bank’s promise to pay a specified return stream based on an underlying asset class—typically commodities or master limited partnerships—through a set maturity date. They also target more esoteric strategies, such as volatility indexes, or make leveraged bets.
Their structure leaves ETN holders subject to counterparty risk if the issuer defaults. In a bankruptcy, unsecured debtholders need to wait in line until secured debtholders are paid, as happened when Lehman Brothers defaulted on its ETNs in 2008. But it’s more likely that ETN holders will run into other difficulties.
When banks create strategies to launch ETNs, they pick a maturity date and need to hedge the strategy’s exposure. They often choose to redeem these vehicles before maturity, says Elisabeth Kashner, director of global fund analytics at FactSet. And in many cases, that’s the best outcome for ETN holders, she says.
Banks can also delist notes without redeeming them, relegating the ETN to trade on the pink sheets and become “zombie securities,” Kashner says. “You’re really toast when that happens,” since that market is thinly traded.
Nate Geraci, president of the ETF Store, a financial advisory firm, says investors may get little warning when a bank delists an ETN. Holders of ETNs trading on the pink sheets still pay the annual expense fee—which averages around 0.80%—until they can sell, or hold until maturity, which can be years away.
About 80% of all ETNs ever launched have either matured, were redeemed, or have delisted, Kashner says.
| Exchange-Traded Note / Ticker | Expense Ratio | Assets Under Management | YTD Net Flows (mil) |
|---|---|---|---|
| J.P. Morgan Alerian MLP Index / AMJ | 0.85% | $2.7 billion | -$16.9 |
| MicroSectors U.S. Big Oil Index 3X Leveraged / NRGU | 0.95 | 1.6 | 0.0 |
| MicroSectors FANG+ Index 3X Leveraged / FNGU | 0.95 | 1.3 | 47.0 |
| iPath Bloomberg Commodity Index Total Return / DJP | 0.7 | $700.7 million | -41.4 |
| iPath Series B S&P 500 VIX Short-Term Futures / VXX | 0.89 | 396.2 | 160.2 |
| MicroSectors Solactive FANG & Innovation 3X Leveraged / BULZ | 0.95 | 368.5 | 0.0 |
| Credit Suisse X-Links Crude Oil Shares Covered Call / USOI | 0.85 | 348.5 | -1.6 |
| Barclays ETN+ Select MLP / ATMP | 0.95 | 254.5 | 10.7 |
| Etracs Alerian MLP Infrastructure Index / MLPB | 0.85 | 238.3 | 0.0 |
| MicroSectors Gold Miners 3X Leveraged / GDXU | 0.95 | 154.5 | 0.0 |
Note: Data through April 10.
Source: FactSet
Credit Suisse (ticker: CS) currently has four actively traded U.S.-listed ETNs it supports, including the $315 million
Credit Suisse X-Links Crude Oil Shares Covered Call
ETN (USOI), which had seen about $11 million in inflows this year.
UBS Group
(UBS), which agreed to take over Credit Suisse last month, declined to comment about its plans for the latter’s ETNs. UBS has its own suite of U.S.-listed ETNs, about 30 in all.
The uncertainty highlights the inherent risks in ETNs. Geraci says the last time an ETN closure made headlines was in 2018, when Credit Suisse’s VelocityShares Daily Inverse VIX Short-Term ETN plunged and briefly triggered broader market turmoil. The ETN was a bet on low stock volatility. When volatility spiked, returns plummeted and the bank abruptly delisted the note. The bank eventually closed the ETN, leaving holders with pennies on the dollar.
Why buy ETNs? For tax efficiency and market access. Since ETNs don’t own any assets, they generally don’t distribute dividends or interest payments; investors pay only capital-gains taxes when they sell.
ETNs can offer investors exposure to difficult-to-access markets like commodities or certain financial instruments like volatility indexes. Some investors prefer commodity ETNs to ETFs for tax reasons, as commodity ETFs often issue K-1 tax forms.
ETNs have about $10.8 billion in total assets, up about $1 billion from a year ago, but much less than ETFs’ $6.7 trillion. If banking woes hit ETNs, Geraci worries it could put ETFs in a bad light if retail investors confuse the two.
“I believe the ETN structure should be taken out behind the barn and shot,” he says. “There are too many examples where ETN holders have been burned over the years.”
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