Toroso: ETNs Should Go Away

David Dierking

As someone who covers the ETN space from time to time, this article from Dan Weiskopf at Toroso Investments caught my eye.

Weiskopf's contention is that the ETN market is shrinking and there are a number of flaws with these products. In particular, he notes tracking errors, a lack of liquidity and the risk of being delisted by their sponsors.

I don't know if I'd necessarily agree with the notion that they need to go away, but they are dangerous for many investors. The main reason is that they are misunderstood by most investors and they're very different products than ETFs despite sharing the "ET" part of the name.

ETNs are, in reality, more like bonds than stocks. A person who buys a bond is essentially lending the issuer money in exchange for the eventual return of that principal plus a promised interest payment. ETNs work similarly, except that the "interest payment" is usually in the form of a return on an index, perhaps using leverage in the process. And just like bonds, they default if the issuer defaults.

We've seen Robinhood traders load up on several ETNs this year, notably the VelocityShares Daily 2x VIX Short-Term ETN (TVIX). It got delisted recently and now trades as TVIXF on the OTC market. A lot of TVIX shareholders didn't understand what the delisting meant and are now struggling to unload their shares.

We saw it earlier this year when the oil market collapsed and a number of oil ETFs and ETNs ended up closing shop.

I'd venture a guess that many investors use the terms ETF and ETN interchangeably assuming that they're essentially the same thing. They're not. In fact, they're very different.

I believe ETNs can have a place in a portfolio, but most investors need a lot more education on the product than they have. The use of leverage by many of these products promise 10-20% yields attracting a lot of income seekers who don't fully understand the risks that come with these yields.

ETNs are far from perfect products and I wouldn't necessarily be upset if they did indeed go away.

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