6.5. Exchange-Traded Notes (ETNs)

Exchange-traded notes (ETNs) are like exchange-traded funds in that they trade on an exchange, and they seek to track the performance of an index. But ETNs are structurally different from ETFs. ETNs are unsecured debt, usually issued by a bank, that promises to pay an amount based on the performance of an index, minus fees. Unlike other debt securities, however, ETNs do not pay interest. They also do not offer principal protection.

Because ETNs are debt securities, investors do not have a claim to any securities. Instead, investors loan the issuer a certain amount of money and receive a promise from the issuer to repay their loan at a future date, based on the performance of the index being tracked. So investors who hold their ETNs to maturity will receive a cash payment that is linked to the performance of the index from the trade date to the date of maturity. ETNs may have maturities as short as a year or as long as 10, 20, 30 and even 40 years. Like other debt securities, they are subject to credit risk because the issuing bank could go out of business.

Recall that traditional ETFs can be subject to tracking error, which means that the ETF is not able to track the index exactly.