Exchange-Traded Notes

June 19, 2006

Barclays launches new “exchange-trades notes” tied to two leading commodity indexes. What’s next? According to Barclays, everything …

You've heard of exchange-traded funds (ETFs) … now get ready for exchange-traded notes (ETNs).

Barclays Bank PLC - a division of Barclays PLC - won approval from the Securities and Exchange Commission (SEC) last week to launch two new commodity-based products. Dubbed "iPath ETNs," the new exchange-traded products track the total return versions of the Goldman Sachs Commodity Index (GSCI) and the Dow Jones AIG Commodity Index (DJ-AIG).[1]  The funds trade on the New York Stock Exchange (NYSE) under the tickers GSP and DJP, respectively.

These are not - I repeat, not - the long-awaited iShares commodity ETFs, which were filed with the SEC last year, and which have been the subject of so much discussion and anticipation. Those funds continue to be reviewed by the SEC, and Barclays Global Investors (BGI) says that the funds are still "slated to launch" sometime in the future.

Instead, these new iPath ETNs are a whole different kind of product. Although they too provide exposure to the commodities market, they are actually debt instruments, and are organized more like structured products than traditional equities. The ETNs will trade like stocks or ETFs, however, and will compete head-to-head with commodities ETFs … including both the already-listed Deutsche Bank Commodity ETF (ticker: DBC) and the pending iShares GSCI ETF.

ETFs/ETNs, Barclays/BGI … it's enough to make your head spin.  The media hasn't done a great job parsing the differences between these products and traditional ETFs, so we'll give it a shot here.

Debt vs. Equity ... But Does It Matter?

In a traditional ETF (or grantor trust, which is how DBC is structured), shareholders own a stake in the underlying assets.  In most ETFs, if you hold enough shares, you (through an Authorized Participant) can redeem those shares directly from the fund for the corresponding value of the underlying assets.  If you own 50,000 shares of SPY, for instance, you can trade it in kind for the corresponding value in all 500 stocks of the S&P 500 Index. Your redemption is in the form of the actual underlying stocks in the fund.

That's decidedly not the case with the iPath ETNs.  The iPath ETNs are debt instruments. When you buy an ETN, you are not buying a stake in the underlying commodity. Instead, you are buying a senior debt note from Barclays PLC. With that debt note, Barclays promises to pay you the exact return of the underlying commodity index - minus an expense ratio of 75 basis points per year.  Barclays will pay that value on a weekly basis, or at expiration (the funds are scheduled to expire after 30 years); in between weekly settlements, the market will set the price.

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