Exchange traded note:

An Exchange-traded note (ETN) is more like a bond. It is an unsecured debt issued by the institution. It can be bought or sold at will and can be held on maturity. If the underwriter were to go bankrupt, the investors would risk a total default.

Before investing in an ETN, research of the credit rating of the underwriter is important.

If the underwriter were to receive a credit downgrade, shares of ETN would likely experience a downturn unrelated to the underlying product.

Because ETN doesn’t buy and sell assets within funds like an ETF, taxes are not triggered until the fund is sold. This will trigger long term capital gains rather than short term capital gains.

Key difference:

Advantage of investing in ETN is the lack of tracking errors. Currently, there are more than 4300 ETF’s in the market. While tracking their respective index they achieve varying leads of success. Investors will notice some amount of divergence from index they track because of the expenses. In response to which funds under-perform compared to the index.

This does not happen with ETNs. As ETN do not rely on buying and selling of the underlying assets, expenses are not collected. When fund matures based on the price of the asset or index, ETN pays to the investors. The fund isn’t tracked actively, therefore, there is no tracking error. Market forces will cause the fund to track the underlying instrument.

Currently there are no funds that track the underlying instrument. But market forces may cause the fund to initiate it.

Which is better?

Those who follow the old rule that says you should invest only into what you understand, then ETF’s are a better choice. Because of stock-like characteristics, part-time investors have an easier time understanding product.  ETN has bond-like characteristics, therefore, it is hard to understand and complicated.

The most popular exchange-traded products are ETF’s. One of the most popular ETN’s is the JP Morgan Alerian MLP Index ETN, which has an average volume of around 1.8 million shares. Path Dow Jones–UBS Commodity Index Total Return ETN (DJP) who’s the daily volume is around 4.51 million. Which shows that investors are heavily weighted towards ETFs.

The bottom line:

ETFs are by means larger in collective volume than ETNs. Much like stocks and bonds, stocks receive more attention from retail investors because they are easier to understand. Financial engineering made our markets more efficient and more liquid.

The big difference between ETN’s and ETF’s is between tax treatment and credit risk.

Key takeaways:

• ETF’s and ETN’s both are designed to track an underlying asset.
• Investing in an ETF’s means investing in a fund which holds the asset in tracks.
• ETN is more like a bond. Which is an unsecured debt not issued by an institution.