An ETF is a fund that owns a portfolio, held by a custodian for its shareholders. An ETN is an unsecured note: a bank promises to pay you the return of an index minus a fee, and owns nothing on your behalf. So an ETN carries a risk an ETF does not, the issuer’s credit, and if the issuer fails, an ETN holder is an unsecured creditor of that bank. For broad stock and bond exposure, the ETF does the same job without that risk.
The difference in one table
| ETF | ETN | |
|---|---|---|
| What you own | A share of a fund that holds securities | A bank’s senior unsecured debt |
| Assets behind it | The portfolio, held by a custodian | None set aside for you |
| If the issuer fails | The fund’s assets are not the sponsor’s to lose | You are an unsecured creditor |
| Tracking error | Small, from holding a real portfolio | None by design: index return minus fee |
| Early closure | Board can liquidate; you get the assets’ value | Issuer call or acceleration clause, per prospectus |
| Annual distributions | Usually, taxed each year | Usually none; currency ETNs taxed on accruals |
| Governing document | Fund prospectus (Investment Company Act) | Note prospectus and pricing supplement |
Why “unsecured” is the whole story
When you buy an ETF, your money buys a slice of a portfolio. If the company that sponsors the fund gets into trouble, the fund’s securities are still there, held for the fund, and still worth what the market says. When you buy an ETN, your money goes to the bank, and you receive the bank’s promise. FINRA’s investor guidance puts it plainly: an ETN’s value is tied to the strength of its issuer, and if the issuer defaults, you might lose some or all of your investment.
That is not a hypothetical. Lehman Brothers launched three Opta ETNs in February 2008. Seven months later Lehman filed for bankruptcy, trading in the notes was suspended, and their holders joined the queue of the bank’s unsecured creditors. The commodity indexes the notes tracked had nothing to do with it. Barclays bought Lehman’s investment banking and capital markets businesses, but did not take on the ETNs.
A downgrade can hurt before a default does. Because the note is a credit instrument, its market value can fall when the issuer’s credit weakens, even while the index it tracks is flat or rising.
The premium trap, in numbers
ETNs stay near their indicative value because the issuer creates new notes when demand rises and redeems them when it falls. If the issuer stops creating notes, that link breaks, and buyers can bid the price far above what the note is actually worth. When issuance resumes, or the market corrects, the premium disappears. Here is what that costs if the index itself does not move at all:
| Premium paid over indicative value | Price paid (value $100) | Sold at value | Your return, index flat |
|---|---|---|---|
| 0% | $100 | $100 | 0% |
| 5% | $105 | $100 | −4.8% |
| 10% | $110 | $100 | −9.1% |
| 20% | $120 | $100 | −16.7% |
| 50% | $150 | $100 | −33.3% |
The loss is premium ÷ (1 + premium). The fix is cheap: every ETN publishes an intraday indicative value, usually under a separate ticker. Compare it with the market price before you buy. ETFs have the same issue in principle, which is why most U.S. ETFs must publish their premium or discount under SEC Rule 6c-11, but their creation process rarely stops.
The closure risk: XIV, February 2018
Credit Suisse’s XIV was an ETN that paid the inverse of the daily move in short-term VIX futures. Its prospectus contained an acceleration clause: if the note’s intraday indicative value fell to 20% or less of the previous day’s closing value, the issuer could redeem it. On February 5, 2018, volatility spiked, the threshold was hit, and Credit Suisse announced an acceleration event. The last trading day was February 20, and holders were paid the closing indicative value on the accelerated valuation date. Reported indicative value had fallen from $115.55 to $4.22 in one session, a loss of about 96%.
The honest comparison is the ETF next to it. ProShares’ SVXY, an inverse-volatility ETF, lost about 96% of its net asset value the same day. The strategy lost the money, not the wrapper. What the wrapper decided was what came next: SVXY kept trading, and its holders could choose whether to stay. XIV’s holders had that decision made for them, at the bottom. Strategies that can lose most of their value in a day are covered in leveraged ETF decay.
Taxes: read the pricing supplement
ETN tax treatment is set out note by note, and it has never been settled by a single rule. Many equity- and commodity-linked ETNs are described by their issuers as prepaid financial contracts, under which you generally recognize gain or loss only when you sell or the note matures, with no yearly distributions. Currency-linked notes are the exception the IRS has ruled on: Revenue Ruling 2008-1 treats them as debt, so accrued interest is taxable every year even though it is not paid until sale or maturity, and gain on sale is ordinary income. ETFs follow ordinary fund rules: distributions are taxed when paid, and in-kind redemptions keep most equity ETFs from distributing capital gains (see how ETFs are taxed and why ETFs are more tax-efficient).
When an ETN is the right tool
- The exposure is hard to hold directly. Some commodity, currency, volatility and strategy indexes are expensive or awkward for a fund to replicate. An ETN delivers the index return without rolling costs or tracking drift.
- The issuer’s credit is strong and the holding period is short. You are lending to one bank for as long as you hold the note. A short trade is a small credit bet; a decade-long holding is a large one.
- You have read the call and acceleration terms. They decide when your position can end without your consent.
For a stock index, a bond index or gold, an ETF gives you the same exposure and owns the assets (see gold ETF vs physical gold for how a physically backed fund is structured). To compare two funds side by side, FundDuel’s ETF comparison tool shows expense ratio, holdings and benchmark on one page, and how to compare ETFs sets out the order to read them in.
Frequently asked
What is the main difference between an ETF and an ETN?
Ownership. An ETF is a registered investment fund that holds a portfolio of securities, and those assets are held by a custodian for the fund's shareholders. An ETN is a senior unsecured debt security issued by a bank: the bank promises to pay you the return of an index, minus a fee, and there is no portfolio behind the promise. If the bank cannot pay, an ETN holder is an unsecured creditor of the bank. An ETF shareholder still owns a share of the fund's assets.
Can you lose all your money in an ETN even if the index goes up?
Yes, in principle. Because an ETN is the issuer's unsecured debt, its value depends on the issuer's ability to pay as well as on the index. FINRA's investor guidance says that if the issuer defaults on the note, you might lose some or all of your investment. This is what happened to holders of the three Lehman Brothers Opta ETNs, launched in February 2008: when Lehman filed for bankruptcy that September, trading was suspended and holders were left standing in line with the bank's other unsecured creditors, regardless of what the underlying commodity indexes did.
Do ETNs have tracking error?
Not in the way funds do. An ETN's issuer promises the index return minus a stated fee, so there is no portfolio to drift away from the index. But the market price of an ETN can drift away from its indicative value, especially if the issuer stops creating new notes. A premium paid on the way in can be lost on the way out even if the index is flat: buying at a 20% premium and selling at indicative value loses 16.7%.
Can an ETN be closed early?
Yes, and the terms are in the prospectus. Most ETNs give the issuer a right to call the notes, and some contain an acceleration clause triggered by a large fall in value. On February 5, 2018, the intraday indicative value of Credit Suisse's XIV fell to 20% or less of the prior day's close, which Credit Suisse announced as an acceleration event; holders were cashed out at the closing indicative value on the accelerated valuation date. An ETF can also close, but its holders receive the liquidated value of assets the fund actually owns.
How are ETNs taxed compared with ETFs?
It depends on the note, and the issuer's prospectus is the document to read. Many equity- and commodity-linked ETNs are described by their issuers as prepaid financial contracts, under which you generally recognize gain or loss only when you sell or the note matures, with no annual distributions. Currency-linked ETNs are different: in Revenue Ruling 2008-1 the IRS held that instruments tied to a foreign currency are debt, so accrued interest is taxable each year even though it is not paid out until sale or maturity. ETFs are taxed on their distributions each year and on gains when you sell.
Is an ETN safer than an ETF?
No. An ETN adds a risk an ETF does not have, the issuer's credit, and removes one the ETF has, tracking error from holding a portfolio. Neither structure makes the underlying strategy safer. On the day XIV was terminated, ProShares' inverse-volatility ETF, SVXY, lost about 96% of its value too. What differed was what happened next: the ETF kept trading, and the ETN was closed.
When does an ETN make sense?
When the exposure is hard for a fund to hold directly, the issuer's credit is strong, and the holding period is short enough that you are not making a long bet on one bank. Examples are some commodity, currency, volatility and strategy indexes where a fund would face rolling costs or tax complications. For broad stock or bond indexes, ETFs offer the same exposure without issuer credit risk.
Sources: FINRA investor guidance on exchange-traded funds and products, and the SEC Investor Bulletin on exchange-traded notes (investor.gov), for the structure and credit risk of ETNs; Credit Suisse’s February 2018 announcement of the XIV event acceleration for the 20% trigger and timetable; contemporaneous reporting (etf.com) for the $115.55 to $4.22 indicative values and SVXY’s one-day NAV decline; IRS Revenue Ruling 2008-1 (Internal Revenue Bulletin 2008-2) for currency-linked notes; SEC Rule 6c-11 (17 CFR 270.6c-11) for ETF premium and discount disclosure. The premium table is arithmetic on a stated $100 indicative value, not the record of any real note. General information, not investment or tax advice.