Investors have been warned: ETNs can deliver surprising results, and not always pleasant ones, says FINRA.
Investors should arm themselves with knowledge before purchasing ETNs, or exchange-traded notes, states the Financial Industry Regulatory Authority in an Investor Alert released yesterday that highlights the numerous risks posed by the debt securities.
“ETNs are complex products and can carry a raft of risks,” Gerri Walsh, FINRA’s vice president for investor education, said in a prepared statement. “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.”
Risk is the top investment criteria of high net worth investors, who also closely consider the diversity of an investment and the tax consequences posed by the product, according the Millionaire Corner research, which also finds that Main Street investors are “risk off” in today’s volatile markets.
An ETN is a specialized type of debt security that offers a return linked to a market index or other benchmark, according to FINRA. The products trade on exchanges as do ETFs or exchange-traded funds, but unlike ETFs, ETNS do not buy or hold assets and are unsecured debt obligations. As such, ETN investors assume credit risk, the risk of default by the issuer of the debt obligation. Think Lehman Brothers.
Credit risk is not the only risk taken on by ETN investors. The products also pose market risk because changing market conditions can cause an ETN to lose value, resulting in a loss of principal to investors. Because a trading market may not develop for an ETN, the products also pose liquidity risk.
Some ETNs, such as leveraged, inverse and inversed leveraged products, are intended to serve as short-term trading tools. According to FINRA, over long periods of time the products can perform much differently than expected, a phenomena known as holding-period risk.
Some ETNs are subject to early redemption risk, according to FINRA, which notes that investors may also face conflicts of interest from issuers engaging in trading activities, such as shorting strategies, that runs counter to the best interests of investors.
FINRA is the largest independent regulator of securities firms operating in the U.S. The agency aims to ensure market integrity and protect investors.