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April 14, 2012

Do you consider Exchange-Traded Notes (ETN) the same as Exchange-Traded Funds?

Samuel Lee, an analyst at Morningstar, the research firm is quoted in Jason Zweig’s column in today’sThe Wall Street Journal.  “When it comes to expenses, I consider all ETNs to be suspect unless you’ve combed through every page of the prospectus.”  “Don’t even try that unless you have a couple of hours, a magnifying glass, a financial calculator and a few pints of strong coffee.”
One of the basics in inveting is that you should only invest it what you understand.  ETF are increasingly being used in portfolios.  There is concern that too many people think ETNs are the same as ETFs.
Costs are one factor that is different.  The costs are generally higher and more difficult to discover than ETFs and mutual funds.  Some are significantly higher.  The “…reported expenses, as high as they sound, might understate the costs.”
Tax efficiencies is one of the advantage of ETFs.  The taxation of ETNs is not as clear.  The income of many ETNs maybe ordinary income, taxed at ordinay income rates rather than lower rates that apply to capital gains.  
ETNs can trade at higher premiums than ETF.  Large ETFs tend to generally trade very close to the underlying index.  ETNs are “generally…structured as borrowings…regulated like bonds…”   
If you are considering ETNs and think you understand ETNs, make sure you understand how they would help your portfolio.  That includes a reasonable expectation that risk is being compensated with higher returns.
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