ETN Providers, Investors Act With Prudence, Not Panic

September 24, 2008

No one is panicking, but the credit crisis has cast a pall over the ETN marketplace.


The credit "brand" image problem that has struck the exchange-traded note market has, at least temporarily, put a hard stop on plans by Invesco PowerShares to launch ETNs. The same caution is now being evinced by financial advisors, who are not pulling out of existing investments, but watching them closely and are most likely steering clear of ETNs with new investment dollars.

The ETN market has grown from 11 funds to 92 funds in the past year alone, and advisors had been investing in ETNs, primarily for commodities, country, and currency exposures. While it has been logical to speculate that the credit crisis' wake would extend to ETNs, now the proof is surfacing in comments from asset managers like PowerShares and financial advisors.

This week, published reports also indicated that Barclays Capital would not own up to the unsecured debt in three Lehman Brothers ETNs—not surprising, but still, adding to the credit brand problem for all ETNs. had previously reported on a looming D-Day (D for Destruction, or D for baD Debt, pick your poison) for the Lehman ETNs (see story).

PowerShares CEO Bruce Bond told that it has put a stop to a planned launch of ETNs, for the foreseeable future. He said the asset manager had some ETNs in the pipeline, though he did not specify asset classes, and he explained that it just doesn't make sense in the current market to go ahead with the ETN plans.

Cautious, Not Hysterical 

Talking to financial advisors, it is not hard to see why PowerShares—or any ETN distributor—would be pulling back the reins on that previously popular asset class. While the advisor sentiment seems to be cautious as opposed to hysterical as far as existing ETN investments, advisors say that in areas where they were considering ETNs for new investments, those investments are not now likely to occur.

Take Pittsburgh-based Legend Financial Advisors, where James Holtzman, advisor and shareholder, has been using ETNs to gain exposure for clients to commodities, countries and currencies. He had been planning to look at ETNs for new investments, and said that when an advisor is building a portfolio with ETNs, one has to assume that credit-related events could occur.

However, the question now for advisors, Holtzman explained, is whether an investment strategy that makes sense outweighs an uncertain credit environment. And it is harder to make the argument that being mindful of a provider's credit rating can even put an advisor's fears at ease.

"One day the CEO says the firm is minimally exposed and the next day they are filing for bankruptcy, so now you can make the argument that a credit rating won't even tell you anything," Holtzman said.

Legend Financial committed assets to ETNs in a measured way because the product space was new, and so it has only a small percentage of assets in ETNs. "We did that on purpose because we didn't want to be too crazy about a new product, and because there were already problems in the credit cycle back when we first invested," Holtzman explained.


As for new investments, though, the firm's thinking has changed. "We're not sure if we will buy anything new, even as far as adding to existing ETNs we use," Holtzman added, and that is notable, since the ETNs being used now by Legend have not raised any red flags. Furthermore, Holtzman said that there is nothing on the ETF side that is an exact replica of styles for which Legend has used ETNs, but still, the firm will now look more to ETFs for similar exposures.

One way market watchers may be able to gauge if a considerable dollar shift is taking place between similar ETNs and ETFs will be to watch future asset movement in Barclays Global Investors' commodities ETF and ETN, which are pegged to the same index: the iShares S&P GSCI Commodity Indexed Trust (NYSEArca: GSG) and the iPath S&P GSCI Total Return Index ETN (NYSEArca: GSP).

At Van Eck Global, which is the distributor for Morgan Stanley-backed Market Vector ETNs, redemptions have risen recently, but the company can't trace it directly to the credit environment. In its Chinese Renminbi/USD ETN (NYSEArca: CNY), redemptions have been a little higher than normal, but there is not enough information at this point to draw any direct connection, said ETF director Adam Phillips.

The Double Short Euro ETN (NYSEArca: DRR) has also seen higher redemptions, but given the recent movement back and forth in the U.S. dollar, it is impossible at this point to pinpoint a reason for higher-than-normal redemption activity vis-à-vis either currency or credit concerns.

Checking Under The Hood 

Incoming calls from Market Vector ETN shareholders have also increased, but in those cases, it is investors who were not aware of the credit side of ETNs, or just want to explore the issue in more detail now. However, Phillips stressed that Van Eck has always been up front about the differences between ETFs and ETNs.

"Nothing really changes for us as distributor, other than fielding more calls than usual given the credit environment, which is expected. But with the way we market ETNs, we have always schooled our marketers to talk about the structural side of the investments," Phillips said.

Does this mean the ETN market, growing quickly but running headlong into the worst of the credit crisis, could stop short of meeting the critical mass and market acceptance needed for long-term survival?

Holtzman doesn't believe that will be the case, and PowerShares' Bond only believes the company is being logical by holding back on new ETNs for now.

"I think it will be a blip, but it might be a long blip," Holtzman said.


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