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What is the difference between ETFs and ETNs (Exchange-Traded Notes)?​

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Differences Between ETFs (Exchange-Traded Funds) and ETNs (Exchange-Traded Notes)

ETFs (Exchange-Traded Funds) and ETNs (Exchange-Traded Notes) are both exchange-traded investment products, but they have significant differences in structure, risk, and behavior. Here's a detailed comparison:

1. Structure
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• ETFs:
  • ETFs are funds that own a portfolio of underlying assets, such as stocks, bonds, or commodities.
  • Shareholders indirectly own these underlying assets.
  • ETFs are structured as open-ended funds or unit investment trusts.
• ETNs:
  • ETNs are debt instruments issued by financial institutions.
  • They do not own underlying assets; instead, they are promises to pay the return of the index or benchmark they track, minus fees.
  • ETNs are similar to unsecured bonds.

2. Ownership of Assets
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• ETFs:
  • ETFs hold physical assets or derivatives that replicate the performance of an index or sector.
  • Investors own a portion of the fund’s assets.
• ETNs:
  • ETNs do not hold assets. Instead, they are a liability of the issuing institution.
  • Investors rely on the creditworthiness of the issuer.

3. Credit Risk
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• ETFs:
  • ETFs have minimal credit risk since they are backed by actual assets.
  • Even if the fund provider goes bankrupt, the assets remain safe in a custodial account.
• ETNs:
  • ETNs carry credit risk because they are unsecured debt.
  • If the issuing bank or financial institution defaults, investors may lose their investment.

4. Tax Efficiency
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• ETFs:
  • ETFs are more tax-efficient due to the in-kind creation/redemption process, which minimizes capital gains distributions.
  • Taxes are usually only incurred when shares are sold.
• ETNs:
  • ETNs are taxed differently; they may have no distributions, so investors generally only pay taxes when they sell the ETN.

5. Tracking Performance
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• ETFs:
  • ETFs may have tracking errors because they hold physical assets or derivatives, and the performance may not perfectly match the benchmark.
• ETNs:
  • ETNs have no tracking error because they are structured to deliver the exact return of the benchmark or index they track (minus fees).

6. Liquidity and Market Risks
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• ETFs:
  • ETFs are highly liquid, and their price is influenced by supply and demand, as well as the underlying asset values.
  • Prices generally stay close to the Net Asset Value (NAV).
• ETNs:
  • ETN prices are also influenced by supply and demand but can diverge significantly from the benchmark during periods of low liquidity or issuer-related events.

7. Costs and Fees
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• ETFs:
  • ETFs generally have lower expense ratios but may incur trading costs such as bid-ask spreads and commissions.
  • Investors may receive dividends from income generated by the underlying assets.
• ETNs:
  • ETNs typically have higher expense ratios and no dividend payouts.
  • Returns are based solely on the performance of the underlying index, less fees.

8. Use Cases
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• ETFs:
  • Commonly used for diversification, hedging, or long-term investments.
  • Suitable for investors seeking exposure to a basket of physical assets like stocks or bonds.
• ETNs:
  • Often used to gain exposure to hard-to-access markets or complex strategies (e.g., volatility indices, commodities, or leveraged products).
  • Suitable for sophisticated investors aware of credit risk.

Conclusion

​ETFs are generally more suitable for retail investors seeking stable, asset-backed products with low risk. ETNs, while offering unique opportunities, carry issuer credit risk and are better suited for sophisticated investors or those seeking access to specific markets or strategies not available via ETFs.

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