The Financial Industry Regulatory Authority (FINRA) issued an investor alert about the risks involved with exchange-traded notes (ETNs) this week. ETNs are a type of debt security that trade on exchanges and promise a return linked to a market index or other benchmark.
According to FINRA, the difference between ETNs and exchange-traded funds is that ETNs don't buy or hold assets to replicate or approximate the performance of the underlying index. Some of the indexes and investment strategies used by ETNs can be quite sophisticated and may not have much performance history.
It warns that the return on an ETN generally depends on price changes if the ETN is sold prior to maturity (as with stocks or ETFs)—or on the payment of a distribution if the ETN is held to maturity.
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An ETN's closing indicative value is computed by the issuer and is distinct from an ETN's market price, which is the price at which an ETN trades in the secondary market. Investors should understand that an ETN's market price can deviate, sometimes significantly, from its indicative value. If the ETN is trading at a significant premium to its closing or intraday indicative value, investors might want to consider similar products that are not trading at a premium.
"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.
There are numerous risks associated with ETNs, including credit risk, market risk, liquidity risk, price-tracking risk, holding-period risk, call, early redemption and acceleration risk and conflicts of interest. Visit FINRA's website at www.finra.org for more details.
FINRA is the largest independent regulator for all securities firms doing business in the United States.
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