ETFs Vs. ETNs
ETNs like UCI or DPU—unlike ETFs such as the one Van Eck is planning or like DBC and USCI—offer investors direct exposure to an underlying index, minus expenses. ETNs don’t own underlying baskets of securities like ETFs do, which not only eliminates tracking error sometimes associated with ETFs, but also gives ETNs access to parts of the investment universe that are hard to cover.
The catch—and it’s been a big one since the market crash of 2008/2009—is that ETNs are unsecured credit obligations backed only by the faith and good credit of their issuers.
If an issuer goes under, investors essentially forfeit their entire investment. That chance seemed very remote when ETNs first launched in 2006, though it was a real threat during the recent financial crisis. After all, three ETN backed by Lehman Brothers closed in September 2008 after the firm declared bankruptcy, and any investor who held to the bitter end lost out.
Still, some issuers say investors are getting over fears and are now curious about ETN attributes, including tax advantages.
Under prevailing IRS interpretations, commodity ETNs are taxed like zero-coupon bonds. That means investors don’t owe tax on the note until they sell, the note gets called (if it’s callable) or the note matures.
Investors using futures-based ETFs to gain exposure to commodities meanwhile have their positions marked-to-market each year, creating an annual tax bill. ETN investors also have to fill out 1099 tax forms, as opposed to the K1 forms reserved for investors in futures. That’s true even for ETN investors with futures-based holdings.