Exchange Traded Notes (ETNs)

What are they and how do they work?

Exchange Traded Notes (ETN) are generally senior unsecured debt obligations of the issuer, which seek to track the total return of an underlying index or benchmark, minus fees. Investors should be careful not to confuse ETNs with ETFs as there are significant differences between these products, While ETFs generally represent an ownership interest in a basket of securities, ETNs provide no ownership in the underlying securities, market index or other benchmark that they are designed to track. ETNs are not mutual funds and are not registered under the Investment Company Act of 1940. ETNs are often used for currency and commodity sector exposure or other non traditional market indices that can be especially volatile; investors should therefore read the prospectus carefully before investing.

What are some of the Features of ETNs?

Investors often use an ETN to gain exposure to a particular market, commodity, currency, or other "difficult to access" region or sector. ETNs are designed to provide investors a return that corresponds to a particular index return, minus fees. Generally, ETNs are a transparent, cost effective way to access market segments using an exchange traded vehicle. Investors may choose to use ETNs for added portfolio diversification or to assist in the tax management of their portfolio.

Investors might choose to utilize an ETN if:

• The investor seeks to invest in a particular market, sector or commodity index that is not available with more traditional indexed products like ETFs.
• An ETN may be a cheaper way to track an index (compared to, for example, an ETF or an indexed mutual fund that tracks the same index).
• In some cases, the tax treatment of certain ETNs may be more favorable for a particular investor than other investment options* (compared to an ETF that attempts to track the same index).
• An ETN can track a particular index more closely than a comparable ETF (e.g., it could have a lower "tracking error"), because an ETF typically holds a basket of securities representing the index, while an ETN "note" is simply a promise of the issuer to pay a certain amount based directly on the price of the index.

What are some of the Risks of ETNs

An ETN is generally a senior unsecured debt obligation of the issuer, which means it is not collateralized or backed by a pledge of assets. Therefore, ETNs are fully exposed to the credit risk of the issuer and dependent on the ability of the issuer to pay its obligations under the terms of the notes. If the issuer becomes insolvent, goes bankrupt, or otherwise cannot pay on the note, the investor can lose all or part of the investment. Although it is a debt instrument, the ETN itself may be unrated, so assessing and understanding the creditworthiness of the issuer should be part of an investor's analysis in determining the suitability and risk level of an ETN. In addition, some ETNs have call features or other early redemption or repurchase provisions which allow the issuer, at its option, to redeem the ETN prior to the stated maturity date. Early redemption of the notes by the issuer may significantly and adversely impact the value of the ETN and limit potential upside returns.

The tax treatment of ETNs is unclear. The IRS and members of Congress have expressed concern about the favorable tax treatment ETNs appear to enjoy currently; and at least one legislative proposal has been made to change the way ETNs are taxed. Note that leveraged and inverse ETNs carry additional risks, as described in their prospectuses.