The ETN Universe Is Shrinking

With the almost-rabid interest in commodities, you would think that ETNs would be launching left and right. Why is the universe of ETNs shrinking, even as the demand for commodities products is expanding?

In addition to unique advantages, ETNs have unique risks. Since they track notes, which are essentially promises made to investors by banks, they are subject to the credit of the issuing bank. In an era where bank failure isn't something you need a lot of imagination to visualize, this structural risk should be a concern for investors.

Lehman Brothers, for example, launched three ETN products before going out of business. Investors who kept their money in these products until the collapse of Lehman walked away with zero.

The likelihood that Barclays, the issuer of iPath ETNs, will collapse overnight is pretty remote. Potential ETN investors, however, should be wary of the credit rating of issuers and keep an eye on the issuing bank.

A more practical, and pressing, issue for ETN investors is liquidity. While a lot of these ideas look great on paper, they have failed to attract investor interest in the open marketplace. When buyers and sellers are not present, funds tend to trade further away from their underlying values. Investors may have to buy a fund at a premium, only to sell it at a discount, if the fund is illiquid.

While the number of ETN products has been declining, assets in the remaining products have been increasing. Total ETN assets nearly doubled from October 2008 to 2009, as the fittest ETNs survived, and thrived.

ETNs have failed when it comes to investor education. These products can be useful for the right investor in the right sector. Investors who are interested in ETNs should first understand the unique credit risks and secondly, use products that have proved themselves in the open market.

-- Written by Don Dion in Williamstown, Mass.

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