US regulator FINRA warns investors of risks of ETNs

Jul 15th, 2012 | By | Category: ETF and Index News

The Financial Industry Regulatory Authority (FINRA), the independent regulator of securities firms operating in the US, has issued an ‘Investor Alert’ to investors warning them of the features and risks of Exchange Traded Notes (ETNs).

US regulator FINRA warns investors of risks of ETNs

“ETNs are complex products and can carry a raft of risks. Investors considering ETNs should only invest if they are confident the ETN can help them meet their investment objectives and they fully understand and are comfortable with the risks,” said Gerri Walsh, Vice President, FINRA.

Recent pricing discrepancies involving ETNs such as the JP Morgan Alerian MLP Index ETN (AMJ) and the VelocityShares Daily 2x VIX Short Term ETN (TVIX) (see Lawsuit filed against Credit Suisse for VelocityShares TVIX ETNs debacle) have placed a spotlight on the market for these products and highlighted the importance of understanding what ETNs are and how they work before considering an investment.

ETNs are a type of debt security that trade on exchanges and promise a return linked to a market index or other benchmark. Unlike most Exchange Traded Funds (ETFs), ETNs do not buy or hold assets to replicate or approximate the performance of the underlying index.

Whilst ETNs can offer investors convenient and cost-effective exposure to everything from commodities to emerging markets, they can be complex and carry numerous risks – including the risk that the issuer will default on the note or take other actions that may impact the price of the ETN.

In addition, some of the indices and investment strategies used by ETNs can be quite sophisticated and may not have much performance history. The return on an ETN generally depends on price changes if the ETN is sold prior to maturity (as with stocks or ETFs) – or on the payment, if any, of a distribution if the ETN is held to maturity (as with some other structured products).

As FINRA’s ‘Investor Alert’ explains, an ETN’s closing indicative value is computed by the issuer and is distinct from an ETN’s market price, which is the price at which an ETN trades in the secondary market. Investors should understand that an ETN’s market price can deviate, sometimes significantly, from its indicative value.

FINRA notes that if an ETN is trading at a significant premium to its closing or intraday indicative value, investors might want to consider similar products that are not trading at a premium.

“ETNs are complex products and can carry a raft of risks. Investors considering ETNs should only invest if they are confident the ETN can help them meet their investment objectives and they fully understand and are comfortable with the risks,” said Gerri Walsh, FINRA’s Vice President for Investor Education.

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