U.S. securities regulators are warning investors about the peculiar risks associated with exchange-traded notes (ETNs).
The Financial Industry Regulatory Authority (FINRA) Tuesday issued a new investor alert about ETNs. The alert highlights the unique features and risks of ETNs, which are debt securities that offer a return linked to a market index or other benchmark.
“ETNs can offer investors convenient and cost-effective exposure to everything from commodities to emerging markets, but they can be complex and carry numerous risks—including the risk that the issuer will default on the note or take other actions that may impact the price of the ETN,” it says.
FINRA stresses that ETNs are complex products, and it points out that some of the indexes and investment strategies used by ETNs can be quite sophisticated, and may not have much performance history.
The alert details the various, specific risks of ETNs, including market risk; credit risk, as ETNs are unsecured debt obligations; liquidity risk, as trading markets may not develop; early redemption risk, as some ETNs are callable by the issuer.
It also highlights price-tracking risk, whereby market prices differ significantly from indicative values; holding-period risk, which may arise for investors in leveraged or inverse notes that are designed primarily as short-term trading vehicles; and, conflicts of interest, such as issuers of the notes trading against the positions of noteholders.
FINRA’s alert also stresses that investors should understand that ETNs and exchange-traded funds (ETFs) differ in some fundamental and important ways, and it suggests questions to ask when considering investing in these products.
“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.