ETN refers to Exchange-Traded Notes, which are generally bond products issued by investment banks. Originally issued by Barclays Bank PLC in 2006. The main difference between this bond and other forms of bonds is its remuneration. ETN's remuneration is based on the remuneration of a specific market index, minus necessary fees. It does not pay fixed interest or guarantee the principal. Therefore, ETNs can be understood as a combination of bonds and some features of ETFs. It is a structured product that is traded on exchanges, and interest is usually paid only when it is sold.
How is it different from ETFs?
1. The linked indices are different
ETN products track a wider range of targets than ETFs. ETF products typically track stock market indices. Theoretically, it’s possible for ordinary investors to copy the portfolio of ETF products. Investors choose ETF products mostly for cost savings and narrowing tracking error. ETNs are mostly commodity indices, volatility indices, and overseas bond indices. Restricted by investment capabilities or relevant legal policies, the above targets are beyond the investment boundaries of many ordinary investors, which makes them unable to diversify their investments.
2. The efficiency of application and redemption leads to different arbitrage effects
ETFs use a basket of stocks for redemption, whereas ETNs use cash for redemption and is also subject to some restrictions, resulting in low timeliness. This non-physical redemption feature determines that its arbitrage efficiency is not as good as that of ETFs, so the discount and premium rate is generally higher than that of ETFs.
3. Different rates and tax rates (primary market)
Generally speaking, because the investment target of ETNs is alternative assets, the fee is generally higher than that of ETFs. Since ETFs adopt the physical redemption, if the redemption is made in the short term, investors do not need to pay the capital gains tax immediately. In contrast, ETNs are redeemed in cash, and the capital gains tax is required to be paid when they are is sold. If holding ETFs for a long time, investors will be forced to pay capital gains tax or general income tax when there are regular adjustments, stock reductions, and dividends. ETN It is treated as a "prepaid contract" for tax purposes, meaning investors do not hold securities and there are no intermediate dividends, so capital gains tax is only charged on final redemption. Overall, ETNs have tax advantages over ETFs.
4. Different tracking errors
The returns of ETF products are entirely dependent on the performance of the fund's portfolio. Due to issues such as position opening costs and asset allocation ratios, ETFs will inevitably generate tracking errors when replicating index returns. The return of an ETN product is entirely decided by the product contract and the performance of the virtual portfolio on top of the issuer's credit. The issuer usually promises the same return as the target, with almost no tracking error.
5. Fundraising is used for different purposes
As a special form of public offering fund products, ETFs can only be invested in the way specified in the prospectus, require separate financial accounting, and are subject to the supervision of the fund custodian. Funds raised by ETFs are included in owners' equity on the fund's balance sheet. ETF assets will not be used until bankruptcy proceedings are carried out. Therefore, it is a fund that belongs entirely to shareholders. While ETNs are a new type of debt financing method. They are included in the issuer's liabilities and usually issued by commercial banks or investment banks. Its funds can be used to supplement the company's working capital and other directions, and it is no different from the company's other debts of the same level.