An exchange-traded note (ETN) is a type of debt instrument designed to reflect the performance of a market index. Even though they are considered debt products, they operate similarly to stocks since they are traded on exchanges and their prices can change. Plus, unlike bonds, they don’t offer interest payments.
How Exchange-Traded Note Works
An ETN is usually issued by financial institutions and its return is linked to a market index. ETNs are a kind of bond. When they reach maturity, the ETN pays out the return of the index it follows. However, unlike bonds, ETNs don’t offer any interest payments.
When the ETN matures, the financial institution deducts fees and then provides the investor with cash based on how the underlying index performed. Since ETNs are traded on major exchanges like stocks, investors can buy and sell them, profiting from the difference between the buying and selling prices, after accounting for any fees.
ETNs are not the same as exchange-traded funds (ETFs). ETFs actually own the securities in the index they track. For instance, an ETF that follows the S&P 500 will hold all 500 stocks in that index.
ETNs don’t give investors ownership of the securities; they simply receive the return generated by the index. Because of this, ETNs are akin to debt securities. Investors need to have faith that the issuer will deliver on the return based on the underlying index.
Barclays Bank PLC was the first to issue ETNs back in 2006. Typically, banks and other financial institutions issue ETNs at a price of $50 per share. The market price is partly influenced by the performance of the underlying index.
The Example of Exchange-Traded Note
The JPMorgan Alerian MLP Index ETN (AMJ) is an ETN focused on energy infrastructure. It follows companies in the energy sector that operate as master limited partnerships (MLPs). MLPs are publicly traded partnerships, and many of them play a key role in developing the energy infrastructure across the U.S.
Investors need to be aware of the risks associated with ETNs. These risks encompass not just the credit risk of the issuer but also the possibility that the share price of the ETN could drop significantly, similar to what happened with AMJ.
The Risks
Exchange-traded notes (ETNs) come with several risks, including liquidity risk, credit risk, closure risk, volatility risk, and price deviation risk.
Conclusion
Exchange-traded notes (ETNs) offer an easy way to get into debt securities. Basically, an ETN is a debt instrument from a financial institution that follows an index. Unlike an ETF, you don’t actually own the underlying security, and instead, the ETN investor gets paid based on the index’s performance.