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What's Really in that ETF You Just Bought?

Feb 15, 2018

A savvy car buyer knows to always take a look under the hood before making a purchase. Equity investors should do the same. As Rachel Evans astutely explores in her piece “ETF Investors Might Not Really Know What They’re Buying Anymore”, many unwitting investors were taken for a ride this week due to their inability to identify a simple, but key, differentiation. Sophisticated investors are likely aware of the variance between an ETF and an ETN.

ETFs have become an increasingly attractive investment portal as they represent a cheap substitute for mutual funds. In terms of scale, ETFs have managed to triple their worth to US$3.4 trillion in assets over the last six years alone. The mainstream rise of ETFs has contributed to the increasingly popularity of ETNs, a similar vehicle, but with subtle differences. This has caused many investors to lose sense of what they are investing in. This was abundantly clear during the equity market volatility of the past two weeks.

The rise of the VIX has been covered ad nauseum. What has received significantly less attention has been the demise of the Credit Suisse backed XIV, an ETN play on shorting the VIX. When the VIX soared from 9 to 50, this note lost US$1.9 billion or 90 percent of its value. All in one day. This is when many investors learned what they had really sunk their money into. Unlike an ETF where investors purchase a pool of assets, ETNs are bank issued debt meaning they are often subject to recall at the issuers discretion. This is precisely what happened when Credit Suisse recalled the note, leaving many investors unable to recuperate their losses. Picking a winning investment strategy is not often straightforward, but failing to identify where resources are going can put investors behind from the jump.

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