Diversified portfolios are important for a safer investment. The present-day options are not limited to the domestic market. Investors may seek international exposure, focusing on foreign economies. This realm includes different securities. ETFs and ETNs are two popular choices. Here is how they compare.
Have you ever thought of investing in a foreign economy? Naturally, this option is not for beginners. You need the experience to weigh up all pros and cons. Country-specific ETFs are ideal for people interested in a certain region. Some economies are developing at a rapid pace, which provides a high return on investment. So, how do these instruments work?
How ETFs And ETNs Work
Exchange-traded funds share characteristics with stocks and mutual funds. They may be traded like corporate equity — i.e., bought and sold for profit. ETFs are linked to baskets of securities reflecting a market index, which makes them diversified by nature. In this regard, they resemble mutual funds.
Prices for ETFs are always in flux. They rise and fall throughout the day, following supply and demand changes. The returns, however, do not always mirror the returns on the index they relate to.
Avoiding Typical Confusion
ETFs are registered investment companies. The owner has a stake in the fund which is linked to a certain index. The instrument is often confused with another type of securities — ETNs (exchange-traded notes). Both are bought and sold on the securities exchange.
Indeed, ETNs are somewhat like ETFs. They are also connected to an underlying market index — i.e., a basket of securities. However, they follow a different logic. ETNs are issued as senior debt notes. They are unsecured, and therefore more similar to bonds.
To summarize, ETFs and ETFs are linked to a bundle of assets (market index), but in different ways. ETFs represent a stake in an investment company, while ETNs are an unsecured debt of financial institutions. While conventional bonds pay interest, profit on ETNs depends on the performance of a linked index or benchmark.
A Word of Caution
ETFs and ETNs are bought and sold on the exchange, and the logic is similar to that for other assets. If you have never traded online, begin by learning about FX trading in India and basic opportunities available through ForexTime.
With a live trading account, you can access a wide range of instruments and gradually create a portfolio. Explore currency pairs, stocks and derivatives before delving into foreign investment. ETFs and ETNs are complex tools, and they must be used with caution.
The number of options varies across regions. Some countries offer more ETFs than others. Investors are advised to conduct thorough research before making a decision. See which funds and locations are most suitable for your goals.
The market sees frequent emergence of new ETFs. Today, over 5,000 types of these securities are bought and sold worldwide. Just under a third of them are traded in the US. In India, popular options include:
- EPI — WisdomTree India Earnings ETF
- INCO — Emerging Global India Infrastructure ETF
- INDY — iShares S&P India Nifty Fifty Index ETF
- INXX — EGShares India Infrastructure ETF
- SMIN — iShares MSCI India Small Cap Index Fund
Risks of ETF and ETN Trading
Both instruments are dependent on the performance of the market. For instance, if the index you track collapses, your returns on ETNs and ETNs will shrink. Finally, both instruments may be leveraged. This means you can increase your buying power while magnifying the risks.
Specific Risks of ETNs
As ETNs represent debt, credit risk is the most salient. Of course, you may choose securities from a major bank with a high credit rating. However, this does not mean the issuer is too big to fail. If the bank goes under, you can simply lose your investment.
Another important aspect is liquidity. Today, ETFs in circulation outnumber ETNs. This means the demand for notes is lower, so finding a counterparty for your trades may be problematic.
Conclusion: ETFs vs. ETNs
Exchange-traded funds and exchange-traded notes are sophisticated securities linked to market movements. ETFs represent an actual stake, while ETNs are a form of debt. Both tools can be used for foreign investment, but they are unsuitable for beginners.