Exchange Traded Note (ETN)

An exchange traded note, or ETN, is a type of debt security issued by a bank that trades on an exchange like a stock. When you buy an ETN, you are not buying a piece of a fund or a basket of assets — you are lending money to the issuing bank, which promises to pay you a return linked to the performance of some index or benchmark, such as an oil price index or a volatility index.

This is the key difference from an exchange traded fund (ETF). An ETF actually holds the underlying assets (or something close to them) that back its price, so if the fund company went bankrupt, the assets it holds still belong to shareholders. An ETN holds nothing. It is simply a promise from the issuing bank to pay a certain return. That promise is only as good as the bank's ability to pay, which is called credit risk or counterparty risk.

ETNs are popular for tracking benchmarks that are hard or expensive to replicate directly with physical holdings, such as commodity indices or futures-based volatility products. Because the issuer only has to promise the return rather than actually manage a portfolio of holdings, ETNs can track their benchmark very closely, often with less of the tracking error or drift that can affect some ETFs.

The nuance that trips people up is that an ETN's price depends on two separate things: the performance of the underlying benchmark, and the financial health of the issuing bank. A trader can be right about where an index is headed and still lose money if the market starts worrying about the issuer's credit, or if the issuer decides to call or delist the note early, which issuers are generally permitted to do under the note's terms.