Do you open the finance newspapers each day and wonder what it would be like to use your keen foresight and patience to invest in the market? Perhaps, you believe that the American dollar is going to only gain in strength for the next few decades, or that gold is going to get even more precious in the coming years. Well, if you believe you have that sort of firm resolve, market awareness, and inclination to invest in debt instruments, then investing in exchange-traded notes might be for you.
What are exchange-traded notes?
An ETN is a debt instrument issued by a financial institute such as a bank. It comes with a fixed maturity period, typically ranging from 10 to 30 years. The various ETNs are listed on the stock exchange such as the Bombay Stock Exchange or National Stock Exchange. They can be traded based on demand and supply.
Unlike other debt instruments, an ETN doesn’t generate any interest money for the investor. The investor doesn’t receive any regular payments. The investor’s gains or losses come from the performance of the asset, asset class, or index that it tracks. The investor can choose to sell the ETN before maturity or hold onto it till it matures to get their returns.
Let’s illustrate what an ETN is with an example. Say you hold a particular belief in the value of oil in the coming decades. You invest Rs.1,00,000 in an oil ETN that tracks the price of oil on the financial market. The ETN comes with a maturity period of 20 years. At the end of those 20 years, the value of the ETN increases by 10 percent. This way, you will receive your principal amount of Rs.1,00, 000, plus a 10percent increase of Rs. 10,000. The total amount you receive will be minus the management fee. However, if the value of the ETN falls by 10 percent, then it will be deducted from your principal amount along with the management fee when you sell your units or on maturity.
Characteristics of exchange-traded notes
For the Bloomberg news-watching, Economic Times reading geek in you, an ETN might sound interesting. Let’s explore the various features and attributes of the exchange-traded notes so that by the end of this article, you are ready to consider it as an investment option.
Asset ownership
An ETN does not hold any substantial assets. It merely tracks them. For example, a gold ETN does not buy any gold; it follows the asset or a gold index.
Unsecured debt
An investor is solely dependent on the creditworthiness and promise of the borrower (the issuer) for the repayment of their principal investment plus or minus the gains or losses incurred. The issuer offers no collateral during the issue of the ETN, which can be sold to make up for any losses incurred by the investor.
Liquidity offered
ETNs are traded on exchanges on trading days. This means that the investor can sell their ETNs at the market provided there is a demand for them.
Expense ratio
Like other investment instruments such as mutual funds, exchange-traded notes also come with an annual expense ratio. This expense ratio is essentially the fee charged by the investment manager to cover yearly maintenance, administration, and other costs.
Now that you know the salient characteristics of an ETN let’s look at its core benefits.
Benefits of exchange-traded notes
There are three core benefits of investing in an ETN. They are as follows:
- Save on taxes
The upside of not receiving any regular dividends or interest payments is that the investor does not need to pay any short- term capital gains tax. When the investor gets the lump sum amount at the end of maturity, they will have to pay a long-term capital gains tax which is relatively lower and payable only once.
- Accurate performance tracking
An ETN doesn’t own any of the underlying assets. Hence, it doesn’t require any rebalancing, unlike in an exchange-traded fund. The ETN mirrors the value of the index or asset class it is tracking.
- Access to certain markets
The markets for specific instruments such as commodity futures, currency, and foreign markets can be inaccessible for small investors as they have a high minimum investment requirement and high commission rates. ETNs don’t come with any such constraints making them accessible for even small retail investors.
Conclusion:
Think about your financial goals and risk appetite to assess how suitable it is to invest in exchange-traded notes. For professional guidance on the matter, head to Angel One, one of India’s leading brokerage houses.
