Most of what’s written about ETNs is cautionary in nature, focusing on the credit risk inherent in any debt security. And with good reason; the risks of ETN investing are very real. While most exchange-traded notes are issued by major financial institutions with lofty credit ratings, the last few years have taught investors that credit risk, however negligible, can never be written off completely. But ETNs also offer some potential advantages to investors. For one, they often offer exposure to hard-to-access asset classes and indexes that traditional ETFs may have difficulties tracking accurately or in a cost-efficient manner [see 1,400+ ETFdb Realtime Ratings].
Despite the risks involved, several ETNs have become incredibly popular with investors looking for exposure to everything from emerging markets equities to volatility to commodities. Below, we profile five of the most popular ETF products currently available to U.S. investors.
5. iPath S&P GSCI Crude Oil Total Return Index ETN (OIL)
The cleverly-named OIL is linked to the S&P GSCI Crude Oil Total Return Index, a benchmark that reflects the returns potentially available through an unleveraged investment in the West Texas Intermediate (WTI) crude oil futures contract plus the Treasury Bill rate of interest that could be earned on uninvested cash. Most investors seeking exposure to crude oil prices through ETFs have turned to the United States Crude Oil Fund (USO), which actually buys, holds, and rolls futures contracts (see the Definitive Oil ETF Guide for a look at oil ETF options).
But OIL has become a popular alternative for investors concerned that the costs incurred in USO’s monthly roll process could potentially eat into returns (although since inception in 2006, USO has outperformed OIL by about 550 basis points). This ETN currently has more than $600 million in assets.
4. JP Morgan Alerian MLP Index Exchange Traded Notes (AMJ)
AMJ tracks the Alerian MLP Index, which is a market-cap weighted, float-adjusted index designed to track the performance of the energy Master Limited Partnerships (MLP) sector. The majority of MLPs currently operate in the energy infrastructure industry, owning assets such as pipelines that transport crude oil, natural gas and other refined petroleum products. The index to which AMJ is linked consists of the 50 most liquid securities that are Master Limited Partnerships, all of which are based in the U.S. (see ENY vs. AMJ: Energy Income Funds Head-to-Head).
AMJ pays a variable quarterly coupon linked to the cash distributions paid on the MLPs in the index, less accrued tracking fees. Because these ETN coupons are reported on Form 1099s, they eliminate the need for K-1 forms (and the administrative burden that comes along). AMJ is less than a year old, but this ETN has become tremendously popular; assets now exceed $850 million.
3. iPath S&P 500 VIX Short-Term Futures ETN (VXX)
The CBOE Volatility Index (better known as the VIX and also referred to as the “fear index”) is one of the most widely-followed benchmarks on Wall Street. But until recently, investment in the VIX wasn’t possible. Recent years have seen the development of VIX options and futures, and last year iPath launched two ETN products offering exposure to equity market volatility. VXX is linked to the S&P 500 VIX Short-Term Futures Index TR, which offers exposure to a daily rolling long position in the first and second month VIX futures contracts and reflects the implied volatility of the S&P 500 Index at various points along the volatility forward curve [see Free 7 Simple & Cheap All-ETF Portfolios].
VXX has delivered poor returns since inception (it was launched near the peak of the VIX) but interest has been impressive; this ETN now has about $1.2 billion in assets. A word of caution on VXX: while it exhibits a strong correlation with the VIX, this ETN is linked to a futures-based index, meaning that it is often impacted by contango in VIX futures markets (see Warning: Three ETFs That Could Be Crippled By Contango).
2. iPath MSCI India ETN (INP)
While most ETNs focus on commodities and other “exotic” asset classes, one of the largest is linked to the MSCI India Total Return Index, a free-float-adjusted market capitalization benchmark designed to measure the market performance of Indian equities. This index consists of 60 companies listed on the National Stock Exchange of India, and maintains the heaviest allocations to the financials (24%), energy (16.6%), information technology (16.4%), and materials (12.4%) sectors.
In most cases, traditional equity ETFs that buy and hold equity securities will be preferable to ETNs linked to stock benchmarks. But INP has become popular with investors in part because it avoids potential inefficiencies associated with maintaining a portfolio of emerging market equities. Assets are currently just north of $1 billion. INP is the largest of the four India ETPs, with assets nearly equal to EPI, PIN, and INDY combined.
1. iPath Dow Jones-UBS Commodity Index Total Return ETN (DJP)
There are a number of ETNs offering diversified exposure to commodity prices, but none have seen the level of investor interest as DJP. This ETN tracks the Dow Jones-UBS Commodity Index, which tracks the performance of a basket of diversified commodities traded in the U.S. Among its largest holdings are WTI crude (16.7%), copper (11.6%), and natural gas (8.0%).
Despite the fact that UBS offers an ETN linked to the exact same index (DJCI) at a significantly lower expense ratio (50 basis points for DJCI compared to 0.75% for DJP), this ETN has seen assets grow to more than $2.1 billion.
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Disclosure: No positions at time of writing.