What is Leveraged ETN Tracking and How Does it Work

Written by admin on May 16th, 2011

An ETN or an Exchange Traded Note is a senior, unsecured, unsubordinated debt security, which is issued by an underwriting bank. ETNs are backed only by the credit of the issuer and they also possess a maturity date.


Leveraged ETN tracking is designed for investors in order to provide access to the returns of various market benchmarks. The returns of ETNs are linked to the performance of a market benchmark or strategy, from which investor fee is then deducted. Upon buying an ETN, the underwriting bank promises to pay the investor the particular amount reflected in the index, minus fees charged upon maturity. Therefore ETNs have an additional risk in comparison to an ETF. If the credit ratings of the underwriting bank goes down or if it goes bankrupt, the value of the ETN gets eroded.


The ETN possesses a very nifty architecture, which is gaining respect and funding in the market. By 18 July 2006, within a month of the launch of the first two ETNs, GSP and DJP, GSP attracted assets worth more than million, whereas DJP had pulled in more than 0 million for Barclays. By late April 2007 investments in iPath ETNs surpassed billion. It took Barclays only a year to accumulate a total of billion in eight funds. Now, other financial institutions are trying to get into the ETN space due to its early success with Barclays.


Leveraged ETNs tracking provides the investors a broad-based index without any tracking error to the index. This tracking facility has omitted the discrepancies that had existed between the returns of many ETFs (Exchange Traded Funds) and their critical indexes. Tracking error used to come in the ETFs due to diversification issues that originate from the unaptness of a fund to duplicate an index due to an upper limit on the maximum asset allotment to a single stock.


Although, in situation of ETNs, this trouble does not exist. ETNs also track the index, but its return is not based upon the underlying securities. The underwriting bank which issues the ETN, guarantees the holder a return which assuredly replicates the underlying index, minus expense fees. In case of awesome shareholders, the exact value of the note is paid back by the bank on a weekly basis through redemption. This helps the ETNs track very nearly to the underlying index return.


ETNs are debt instruments, which are subject to risk of default by the issuing bank as counter party. There is a major contrariety in design between an ETF and an ETN. ETNs attract more risk decently because it is subject to both market risk and the risk of default by the issuing bank compared to just the market risk, in case of ETFs.


As of now, ETNs have confirmed to be beneficial performers. They are a new kind of structured product with lower fees, better liquidity and tax-efficiency. Although, both financial institutes and investors should be really appercipient of the status of the tax opinion from the IRS on ETNs while seeking ETNs as business or investment possibilities.

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