Exchange Traded Note

The exchange traded note, or ETN, was introduced to the investment community back in mid-2006 by Barclays Bank; the largest provider of exchanged traded funds, or ETFs.  These two fund types have a lot in common, and the difference is important to understand.

In this article, we're going to start by defining the term exchange traded note, and we'll explain how they are related to exchange traded funds.  We'll also talk about the tax treatment of these investments, as well as their risk.  Finally, we'll finish up with a brief description of the ETNs found on the market today.

Exchange Traded Notes

Exchange traded notes are investment instruments managed by Barclays Bank PLC, which is a unit of the London based Barclays PLC.  ETNs are an unsecured debt security issued by Barclays.  The return on these notes is based upon the performance of a market index, or in the case of a currency ETN an exchange rate.

An ETN is like a bond whose return to the investor depends on the performance of an exchange traded fund.  It's certainly no accident that Barclays Global Investors, located in San Francisco, is the largest issuer of exchange traded funds, which are also sold on the market as iShares.  When an investor buys an ETF, they are buying the portfolio of investments held by the fund, and their return on investment depends on the performance of the index itself.

ETNs versus ETFs

With the iPath, which is the name used by Barclays to market and sell exchange traded notes, an investor buys a 30-year debt security listed on the NYSE Euronext.   The iPath will provide the investor with the underlying index's return less a 40 to 75 basis point fee.  The advantage over purchasing the index, or ETF, directly stems from the fact that Barclays guarantees the index's return.  This eliminates index tracking error, which might result in the ETF under-performing relative to the index it's tracking.

Just like ETFs, the ETN is bought and sold during normal trading hours on the NYSE Euronext.  Investors can also choose to hold onto the security until maturity, just like a note or bond that's issued by a large institution.  When Barclays created these investments, they were trying to combine the best features of bonds with those of exchange traded funds.

The final difference worth noting is that ETFs carry with them index tracking risk, while ETNs possess credit risk as explained in the next section.

Risk and Return

As mentioned earlier, ETNs are unsecured debt issued by Barclays.  As such, the investor assumes the credit risk associated with the issuer, just like an unsecured bond.  This means the return on exchange traded notes is based upon two factors:

  • The return on the index it's tracking
  • The creditworthiness of Barclays

If the credit rating of Barclays Bank were to suffer a downgrade, the value of the ETN would also suffer.  Keep in mind that Barclays started back in 17th century London, over 300 years ago.  The company has nearly 125,000 employees, and boasts 27 million customers.  They're also managing $1.8 trillion in assets on behalf of investors.

According to Standard & Poor's, Barclays Bank PLC also has an issuer credit rating for long-term debt of AA, and this rating has remained unchanged since 1994.  Barclays does carry some credit risk, and any investor purchasing a security issued by the company should be aware this threat exists.

Tax Treatment

Barclays recommends that investors treat ETNs as prepaid contracts.  This means the difference between the purchase price of the security and the price at which it was sold should be treated as a capital gain for income tax purposes.  Unlike a note or bond, there are no periodic distributions to the investor.

Since the entire gain is treated as a capital gain, the investor can defer this gain until the security is either sold or it matures.  Control over the timing of this gain is a big benefit to any investor looking to defer the payment of income taxes.

ETNs Offered by Barclays

The ETNs currently offered by Barclays fall into four categories:

  • Commodity
  • Emerging Market
  • Currency
  • Strategies

Each of these categories is explained in more detail below, along with a brief description of each of the actual ETNs offered on the market today.

Commodity ETN

This first group of exchange traded notes falls into the commodities category.  Generally, commodities refer to raw materials and assets such as oil, natural gas, precious metals, agriculture, and livestock.   These ETNs are traded on the NYSE, and carry fees of 0.75% per year.

iPath - Dow Jones-AIG Commodity Index Total Return ETN (DJP / DJP.IV)

The return on this investment is linked to the performance of the Dow Jones-AIG Commodity Index Total Return.  This index is designed to be a diversified benchmark for commodities as an asset class, and reflects the returns that are potentially available through an un-leveraged investment in the futures contracts on physical commodities comprising the index plus the rate of interest that could be earned on cash collateral invested in specified Treasury Bills.

The index is composed of nineteen futures contracts on physical commodities traded on U.S. exchanges, with the exception of aluminum, nickel, and zinc contracts, which trade on the London Metal Exchange.

iPath - S&P GSCITM Total Return Index (GSP / GSP.IV) ETN

The return on this investment is linked to the performance of the S&P GSCI Total Return Index.  This index reflects the excess returns that are potentially available through an un-leveraged investment in the contracts comprising the S&P GSCI Commodity Index, plus the Treasury Bill rate of interest that could be earned on funds committed to the trading of the underlying contracts.

The S&P GSCI is a production-weighted index of the prices of a diversified basket of futures contracts on physical commodities traded in major industrialized countries.

iPath - S&P GSCITM Crude Oil Total Return Index ETN (OIL / OIL.IV)

The return on this investment is linked to the performance of the S&P GSCI Crude Oil Total Return Index.  This index is a sub-index of the S&P GSCI Commodity Index and reflects the excess returns that are potentially available through an un-leveraged investment in the contracts comprising the index, plus the Treasury Bill rate of interest that could be earned on funds committed to the trading of the underlying contracts.

The only contract currently used to calculate the index is the West Texas Intermediate ("WTI") crude oil futures contract traded on the New York Mercantile Exchange.

Emerging Market ETN

As part of a diversified investment portfolio, emerging markets offer the opportunity to participate in faster growth segments.  Many of today's fastest growing companies are located in developing countries overseas.  This ETN is traded on the NYSE, and carries a fee of 0.80% per year.

iPath - MSCI India Index ETN (INP / INP.IV)

The return on this investment is linked to the performance of the MSCI India Total Return Index.  This index is a free float-adjusted market capitalization index that is designed to measure the market performance, including price performance and income from dividend payments, of Indian equity securities.  The index is composed of the top 70 companies by market capitalization listed on the National Stock Exchange of India (the "NSE").

Currency ETN

This next set of exchange traded notes involves currency plays.  By investing in foreign exchange, or forex, the investor has a chance to take advantage of the relative strength of one economy, and therefore the strength of their currency, compared to that of another foreign economy.  These three currency ETNs offered by Barclays are traded on the NYSE, and carry fees of 0.40% per year.

iPath - JPY/USD Exchange Rate ETN (JYN / JYN.IV)

The return on this investment is linked to the performance of the Japanese yen / U.S. dollar exchange rate, which is the number of U.S. dollars that can be purchased for one Japanese yen: the JPY/USD exchange rate.  The exchange rate is determined by dividing one U.S. dollars / Japanese yen as reported after 10:00 by Reuters to ten decimal places.

When the Japanese yen appreciates relative to the U.S. dollar, the U.S. dollar / Japanese yen exchange rate will decrease.  The JPY/USD exchange rate will increase, and the value of the ETN increases.  When the Japanese yen depreciates relative to the U.S. dollar, the U.S. dollar / Japanese yen exchange rate increases, the JPY/USD exchange rate decreases, and the value of this ETN decreases.

iPath - EUR/USD Exchange Rate ETN (ERO / ERO.IV)

The return on this investment is linked to the performance of the euro / U.S. dollar exchange rate.  The EUR/USD exchange rate is a foreign exchange spot rate that measures the relative values of two currencies, the euro and the U.S. dollar.  The EUR/USD exchange rate is expressed as a rate that reflects the number of U.S. dollars that can be exchanged for one euro in the interbank market for settlement in two days, as reported each day shortly after 10:00 a.m. by Reuters.

When the euro increases in strength relative to the U.S. dollar, the EUR/USD exchange rate and the value of this ETN will increase.  When the euro depreciates relative to the U.S. dollar, the EUR/USD exchange rate and the value of the ETN will decrease.

iPath - GBP/USD Exchange Rate ETN (GBB / GBB.IV)

The return on this investment is linked to the performance of the British pound / U.S. dollar exchange rate.  The GBP/USD exchange rate is a foreign exchange spot rate that measures the relative values of two currencies, the British pound and the U.S. dollar.  The GBP/USD exchange rate is expressed as a rate that reflects the number of U.S. dollars that can be exchanged for one British pound in the interbank market for settlement in two days, as reported each day shortly after 10:00 a.m. by Reuters.

When the British pound increases in strength relative to the U.S. dollar, the GBP/USD exchange rate and the value of the ENT will increase.  When the British pound depreciates in value relative to the U.S. dollar, the GBP/USD exchange rate and the value of the ETN will decrease.

Strategies ETNs

The strategies ETN offered by Barclays are traded on the AMEX, and carry with them fees of 0.75% per year.  At the present time, Barclays offers one option in the strategies category, and that security is linked to buy-write and covered calls on the S&P 500 Index as explained below.

iPath - CBOE S&P 500 BuyWrite Index ETN (BWV / BWV.IV)

The return on this investment is linked to the performance of the CBOE S&P 500 BuyWrite Index, also known as the BXM Index.  The index is designed to measure the total rate of return of a hypothetical "buy-write", or "covered call", strategy on the S&P 500 Index.

This strategy consists of a hypothetical portfolio made up of a "long" position indexed to the S&P 500 Index and the sale of a succession of one-month, at or slightly out of the money S&P 500 Index call options that are listed on the Chicago Board Options Exchange.  This hypothetical portfolio is referred to as "the covered S&P 500 Index portfolio."


About the Author - Exchange Traded Note (Last Reviewed on September 7, 2016)