What’s The Difference Between An ETF And ETN?
ETF Or ETN: What’s The Difference?
In case you’re unaware, there’s a class of investment products out there that make it relatively easy for investors to profit from movements in commodities and natural resource stocks.
I’m speaking of ETFs and ETNs…
Some examples of these products are the US Oil Fund ETF (USO), Energy Select Sector SPDR ETF (XLE), and the Goldman Sachs Crude Oil Total Return ETN (OIL).
While they’ve been around a few years, ETF/ETN products are still growing in popularity with investors.
According to some sources, ETFs and ETNs may eventually replace mutual funds.
Their instant diversification, ease of understanding, and lower fee structure make them a top choice for investors and traders.
But there are a few things you need to understand about these products before you pile your money into them.
Here’s what you need to know about ETFs and ETNs…
Commodity ETF and ETN: The Similarities
Let’s get the obvious out of the way first…
Both ETFs and ETNs allow investors to invest in assets that may otherwise be unattainable. That asset could be a commodity, a basket of stocks focused towards a specific industry, or an index.
Another similarity is their low expense ratio. In case you missed it, we discussed this hot button issue a few days ago.
Finally, ETFs and ETNs both trade intraday, just like a stock. This alone makes them far more desirable than mutual funds, which can only be bought/sold at the end of the trading day.
Thanks to all these factors, ETFs and ETNs are a simple and efficient means to capitalize off price movements in commodities and various natural resource industries.
But there are some important differences between the two products that you need to understand…
The Big Difference Between an ETF and ETN
The main differentiation between ETFs and ETNs is their internal structure.
When you invest in an ETF, you’re buying into a fund that holds a particular asset.
That asset may be a physical commodity, like gold, silver, or platinum.
It could also be carefully selected futures contracts of a particular commodity. Such is the case with the US Oil Fund (USO), which holds crude futures.
And there’s more…
ETFs can also hold groups of stocks. For example, the Energy Select Sector SPDR (XLE) invests in a basket of companies focused towards oil exploration and production.
When you’re buying an ETF, you’re buying a percentage of an asset, or group of assets.
The same can’t be said for ETNs…
An ETN is an unsecured debt note designed to track a particular market or index.
The most important distinction to understand is that an ETN does not hold the asset it is tracking like an ETF does.
Instead, an ETN is merely a debt instrument backed by a bank.
Speaking of which…
In all cases, ETNs are backed by large financial institutions with high credit ratings.
For example, the iPath family of commodity ETNs is backed by Barclays, which is one of the oldest and most reputable banks in the world.
The most important thing to understand about ETNs is the credit risk…
If the issuer of an ETN suddenly faced credit issues, they may not be able to repay their debt. As a result, investors may lose all their ETN investment if something were to go horribly wrong at the issuing bank.
Now let’s be clear. The collapse of Barclays is extremely unlikely. But for the sake of explanation, if it did happen, the viability of all iPath ETNs would be thrown into question.
In fact, if you read the fine print on Barclay’s commodity ETN page, you’ll find this…
“… the actual and perceived creditworthiness of Barclays Bank PLC will affect the market value, if any, of the ETNs prior to maturity or redemption. In addition, in the event Barclays Bank PLC were to default on its obligations, you may not receive any amounts owed to you under the terms of the ETNs.”
Is this a risk to worry about?
Not in my opinion…
My only point in providing this information is so that you understand the difference between an ETF and ETN.
Which Do You Choose? Both!
Which product is right for you?
Depending on the market situation, ETFs and ETNs are both capable of fitting your investment/trading needs. In my trading, I use both products regularly.
But here’s a tip…
Stick to ETFs and ETNs with good liquidity and tight bid/ask spreads.
For example, if you’re looking to invest in platinum, choose the ETFS Physical Platinum Shares (PPLT) over the iPath Platinum Subindex Total Return (PGM).
PGM (an ETN) is very illiquid. As a result, it’s very difficult to buy and sell at a fair price. On the other hand, PPLT (an ETF) has relatively tight spreads, which make it easier to enter/exit a position.
Until Next Time,
Justin Bennett
Commodity Trading Research
BIO: Justin Bennett is the head commodity research analyst at Commoditytradingresearch.com. With over a decade of real world trading experience, he finds ways for you to consistently profit from movements in commodities and the companies producing them. Sign up for our free reports and commodity newsletter at http://commoditytradingresearch.com/free-sign-up.
Category: Commodities, ETFs
