PHILADELPHIA — Although iPath exchange traded notes have amassed more than $2.6 billion since making their debut more than a year ago, their appeal remains a mystery to some industry experts.
“I kind of sit back, scratch my head and ask what I’m missing about ETNs,” said Jim Lowell, Needham, Mass.-based editor of Forbes ETF Advisor, a monthly newsletter.
Barclays Bank PLC of London launched the first two ETN offerings in June 2006.
They are similar to exchange traded funds in that they follow an underlying index. (See related column on page 19.)
ETNs, however, are debt securities backed only by the credit of the issuer; ETFs typically are registered investment companies and are collateralized by an underlying portfolio of securities.
Proponents argue that ETNs provide efficient access to segments of the market that would otherwise be difficult for retail investors to reach.
Balanced offerings
For example, via the eight ETNs it offered as of the end of last month, Barclays provides access to commodities, emerging markets and currencies.
It even offers access to a
covered-call-writing strategy via its iPath CBOE S&P 500 BuyWrite Index ETN.
They are good options to have when trying to create a diversified portfolio, said David Elan, a principal at Windward Investment Management Inc.
The Boston-based financial advisory firm was an early adopter of the exchange traded note.
He would like to see an ETN that tracks an index of emerging-markets bonds and an ETN that provides access to the uranium market.
But at least one industry watcher said she doesn’t know if such products are a good idea.
“Those sort of worry me,” said Sonya Morris, editor of Morningstar ETFInvestor, a monthly newsletter published by Morningstar Inc. of Chicago.
Many of the markets Barclays is targeting with its ETNs are so narrow that they would be dangerous for retail investors, she said.
That said, proponents maintain that ETNs are unlikely to fall into the hands of investors who don’t understand the risks.
For starters, they aren’t being aggressively marketed, according to Philippe El-Asmar, a New York-based managing director with Barclays.
“They are bought, not sold,” he said.
Of course, the same once could have been said about ETFs, but with the advent of more players, that has changed.
And although Barclays is currently the only major player pushing ETNs, other industry participants will probably soon follow, Mr. El-Asmar said.
“We hear that a lot of people are trying to replicate what we have achieved,” he said.
That others could soon offer ETNs makes sense to Mr. Elan.
In addition to offering access to hard-to-reach segments of the market, ETNs come with no tracking error and are very tax efficient — even more efficient than ETFs, he said.
In some ways, ETNs are an improvement on ETFs and could one day represent a threat to ETF development, suggested Jim Wiandt, president of Index Publications LLC of New York.
“I think that the structure has the possibility … [to change the whole landscape of exchange traded products],” he said.
Mr. Lowell, who is developing a line of ETFs of his own, is doubtful that ETNs will have a major effect on the industry.
The tracking error of ETFs is so miniscule, and their tax efficiency so great, that any improvement would be barely noticeable by the average investor, he said.
And although it may be true that ETNs can offer investors access to hard-to-reach segments of the market, Mr. Lowell isn’t convinced that ETNs were created for any other reason than to cater to institutional investors who don’t like the fact that ETFs are gaining favor with retail investors.
Institutional investors like to feel they are buying something special, he said.
