ETNs Vs. ETFs

The media has been comparing exchange-traded notes and exchange-traded funds since the first ETN launched in 2006. By now, the outlines of the argument are clear.

ETNs claim to have three big advantages over ETFs: zero tracking error, access to difficult-to-reach markets and greater tax efficiency. Likewise, they come with one major drawback: They are credit instruments and, as such, subject to credit risk.

The reality is that, for most investors and in most situations, the question of which is the better product is moot. The majority of ETNs exist in markets where ETFs do not exist, and vice versa, so weighing issues like tracking error vs. credit risk is pointless. If you want to invest in certain commodities, countries or strategies, ETNs are the only choice.

That is slowly changing as both markets expand, however: ETFs are honing in on territory previously the sole domain of ETNs, while ETNs are intruding on territory formally occupied only by ETFs. And some of the biggest ETNs do compete in areas where ETFs exist. As a result, the question of which is better is becoming very real.

This is made all the more important by the fact that it is often easier and faster for companies to launch ETNs than ETFs. Some wonder if ETN issuers are rushing products into the space just to be the first one out of the box.

“Time to market is always a factor in decision making, so if you could track the same asset in a fund or a note, there could be a competitive advantage to getting it out more quickly with a note,” said Kevin Rich, managing director in Global Markets Investment Products at Deutsche Bank. “From the issuer’s perspective, notes can offer a more expedient process in the way you interact with the regulators on listing, and investors benefit by having [access] to the product sooner. At the end of the day, if a better product comes out, people will vote with their assets.”

“In general, the first-mover advantage is helpful,” said Philippe El-Asmar, managing director of Barclays Bank’s iPath family of ETFs. “But it doesn’t determine success. It matters whether investors want to take the tracking error vs. the credit risk.”

So which should they want?

This story was originally published in ETF Report. For the full article click here.

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