| #twill #tcot #investments #sbalich #ETN #stockmarket |
| Double-Digit Yields in the Time of Zero Interest Rates? |
| Written By Samuel Taube |
| These are dark times for income investors. The S&P 500 yields less than 2% at the time of writing, and the 10-year Treasury yields less than 1%. These payouts are woefully inadequate for most investors’ needs, and many have started to look outside of the conventional stock and bond markets to compensate. One high-yielding product that is starting to see renewed attention on investing forums is the exchange-traded note (ETN). Popular notes like the JPMorgan Alerian MLP ETN (NYSE: AMJ), which tracks an index of oil and gas partnerships, often yield more than 10%. AMJ’s yield currently sits at 13.57%. ETNs can provide investors with yields that are hard to find anywhere else, but they’re also unique and complex securities that carry an unusual set of risks… What Is an Exchange-Traded Note (ETN)? You might assume that ETNs are close relatives of exchange-traded funds (ETFs)… but you’d be wrong. Both can be bought and sold on stock exchanges during normal trading hours, as indicated by the first two letters — but that’s where the similarities end. ETNs are unsecured debt instruments issued by financial institutions and track an underlying index of stocks, bonds, or commodities — like the Alerian MLP Index. But while ETFs are baskets of securities that continuously track their underlying indexes by buying and selling their components, ETNs don’t actually contain their underlying investments, and they mature like bonds. At maturity, an ETN will pay its holder the return on its underlying index over the life of the note. This return is commonly referred to as the ETN’s yield. In that respect, ETNs behave less like funds and more like futures contracts. But they have advantages of both types of investments. The Advantages of ETN Investing The substantial yields ETNs pay their holders at maturity aren’t actually interest or dividend payments, and as a result, the notes have considerable tax advantages over mutual funds, ETFs, bonds, and even common stocks. Without any taxable income distributions, ETN returns are taxed entirely at the lower capital gains rate upon sale or maturity. ETNs also give ordinary investors like us access to assets which can be difficult to find through retail brokerages – commodities, preferred shares, foreign stocks with restrictions on foreign ownership, and so on. And unlike mutual funds or ETFs, ETNs track these underlying assets perfectly, without any discount or premium to net asset value (NAV). After all, they don’t actually track their underlying asset. They simply pay out its percentage return at maturity, less fees. You don’t have to worry about incompetent portfolio management when investing in an ETN because it has no portfolio to manage. But their tax advantages, sky-high yields, and lack of tracking errors are accompanied by a unique set of potential pitfalls which investors must understand before buying in… The Risks of ETN Investing As with ETFs, mutual funds, and other index-tracking products, ETNs can lose value if their underlying assets lose value. But this is just one way ETN investors can get burned. They can also get stiffed by an ETN’s issuer in a crisis. After all, the notes are unsecured debt obligations; they’re subject to default risk just like junk bonds. The credit rating of the issuer is a pertinent consideration for ETN investors; a bank credit downgrade can cause that bank’s ETNs to lose value, even if there was no change in the note’s underlying index. And like bonds, some ETNs carry a risk of early redemption. Investors in UBS’s ETRAC series of ETNs learned this the hard way back in March when the bank forced them to cash in their notes due to COVID-19-related market volatility — resulting in losses of 60% or more. As a relatively small asset class, ETNs can also suffer from occasional liquidity issues. These aren’t necessarily relevant to long-term investors who are looking to buy notes and hold them to maturity, but they can be disastrous for traders. |
