I wish I knew what an ETN was, but I’m too embarrassed to ask

An exchange-traded note (ETN) is a financial security that trades on a stock exchange and is designed to deliver the return on an underlying index to an investor, after fees. That sounds a lot like an exchange-traded fund (ETF), which also trades on a stock exchange and aims to give an investor an easy way to track an underlying index.

However, the structure of the two securities is very different. An ETF usually owns the securities in the index it tracks (or in the case of a synthetic ETF, enters into a swap deal with a bank, which is backed by collateral held by the ETF, whereby the bank agrees to deliver the return on the index).

An ETN, by contrast, is a type of debt security, similar to a bond. The ETN is issued by a bank and, just like a bond, it has a maturity date. The ETN promises to pay the holder the value of its underlying index (after fees) at maturity, although of course it can be traded freely on the exchange. The fact that the ETN is issued by a bank means that it carries credit risk – in the relatively unlikely event that the issuing bank goes bust, the ETN won’t pay out.

The first ETNs emerged in the early 2000s, but were popularised by Barclays Bank in 2006. The goal was to allow private investors to track the sorts of prices that are difficult and expensive to do via ETFs. For example, commodity and currency-tracking vehicles are often ETNs rather than ETFs, while ETNs are also used to track more esoteric indices, such as the Vix, mentioned above.

The ETN structure eliminates the need to hold the underlying asset (although the trade-off is that it exposes the investor to the credit risk of the issuer – which became a significant issue during the 2008 financial crisis). This in turn removes the risk of tracking error (ie, of diverging from the underlying index). However, they are less transparent than ETFs and the complexity of the underlying markets involved means they’re not suitable for most investors.