Due to the exchange-traded note market’s recent problems with price variations and issuer credit risk, the Financial Industry Regulatory Authority (FINRA) has released a new investor alert warning investors to pay close attention to the products’ associated risks before they invest.
Exchange-traded notes (ETNs) are basically unsecured debt obligations of an issuer (typically either a bank or other financial institution) that trade on exchanges and promise a return linked to a market index or other benchmark. Though the name brings up the image of an ETF (exchange-traded fund), ETNs do not buy or hold assets in order to replicate or approximate the performance of the underlying index. They also, unlike typical bonds, do not pay interest payments to investors. Instead, the issuer agrees to pay the investor a “distribution,” based on the performance of the underlying index or benchmark on the ETN’s maturity date, minus specific fees.
The underlying index may be a familiar, broad-based index or it may be a newer, more complex, or proprietary index. Additionally, the maturation date may be decades into the future. These variations make the products difficult for even sophisticated investors to understand, a reality FINRA is afraid investors don’t fully comprehend.
"ETNs are complex products and can carry a raft of risks. Investors considering ETNs should only invest if they are confident the ETN can help them meet their investment objectives and they fully understand and are comfortable with the risks," said Gerri Walsh, FINRA's Vice President for Investor Education.
To learn more about the specific risks associated with exchange-traded notes, read the full FINRA investor alert here.