At first glance, ETFs (exchange-traded funds) and ETNs (exchange-traded notes) may seem very similar. After all, both are designed to track the market performance of a particular asset or group of assets. However, some crucial differences between these two types of investment vehicles can significantly affect how they perform and how you should use them as an investor.
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Structure
One of the key differences between ETFs and ETNs is their underlying structure. In general, ETFs are traditional financial products structured as unit investment trusts or open-end funds, which means they hold a portfolio of assets and issue shares based on the value of those assets – similar to mutual funds. ETNs, however, are structured more like bonds, and investors not only receive a return depending on index performance but also will receive the principal amount at the ETN’s maturity.
Asset class
Both types track various markets, but there is a difference in how the tracking is done. Traditional ETFs focus on more mainstream investments such as stocks, bonds, commodities, real estate, currency pairs, and other ETFs. ETNs track exclusively market indices and other benchmarks, with a greater focus on more niche product areas, such as emerging markets and more niche commodities and currencies.
Exchanges
ETFs are traded on traditional financial exchanges such as the New York Stock Exchange (NYSE). This is the same for ETNs.
Fees and expenses
Because of their structure and underlying assets, ETFs tend to have lower fees and expenses than ETNs do. For example, most mainstream stock and bond ETFs charge annual asset-based fees of around 0.1% or less. ETNs are priced depending how an underlying index is performing.
Liquidity
One of the most significant differences between ETFs and ETNs is their liquidity. Because they are traded on mainstream financial exchanges where there is a large volume of daily trading in various assets, traditional ETFs tend to be highly liquid investments. ETNs, however, can be much less liquid due to the smaller size of the product areas being traded. It may take longer for an investor to find a buyer for their shares when demand for the underlying assets is low.
Regulatory restrictions
ETFs are subject to a wide range of regulations from the SEC and the IRS. ETNs are also well-regulated, as they are usually a bond issued by a large financial institution of good repute. ETN investors also then receive a return on the index they invest in on top of the principal of the ETN at maturity.
Accessibility
Both ETFs and ETNs are relatively accessible for investors. Since they trade on traditional financial exchanges, traders can purchase most ETFs from just about anyone who has an account with a broker or wealth management firm that offers them. Similarly, ETNs are accessible from established banks and financial institutions.
Taxation
Income from ETFs receive the same treatment as income from stock and bond investments. They are labelled capital gains, and investors have to report them and pay taxes as part of their statement. ETF investors also usually have to pay taxes on dividends and make interest rate payments.
When an investor purchases ETNs, however, they do not hold any portfolio securities and they do not receive regular dividends. Therefore, they do not have to file their taxes for short-term capital gains. However, when they sell an ETN, they are very likely to have to file for long-term capital gains.
Risks
Both ETFs and ETNs are relatively secure from risks and cyber-attacks. ETFs, however, possess tracking risk – which is the risk in the index’s performance. An ETN carries both tracking risk and credit risk. The latter occurs because ETNs are issued by banks and financial institutions. If they go bankrupt, the investor will not receive the return they were promised.
Volatility
One of the most significant differences between ETFs and ETNs is their level of volatility. Due to heavy regulation and the relative stability of mainstream financial markets, most traditional ETFs and ETNs are relatively stable investments that go up in value over time. However, as mentioned, ETNs possess both tracking and credit risk, making it a slightly more volatile investment.
You can check here for a selection of ETFs.