I’m actually going to talk about “ETNs” (exchange traded notes), not “ETFs” (exchange traded funds), but the problem is most people don’t know the difference and use the terms interchangeably! If you aren’t 100% sure what you own, now is the time to find out because a major issuer of ETNs, Deutsche Bank, is having major problems
ETFs are entities that stand alone from the company that issued them, the ETF sponsor. They give investors a share of the underlying assets. If the sponsor goes bankrupt, the assets are either liquidated or managed by a new advisor, which means you either get your money back or business continues as usual. Most ETFs are regulated under the Investment Company Act of 1940, a regulation that provides many investors protection.
ETNs don’t actually give you a share of a pool of assets. Instead, they are unsecured debt obligations of the firm that issued them. The debt they owe the investor is a return that corresponds to a benchmark or an index, minus the sponsor’s fee. In the event of sponsor bankruptcy, the investor joins the list of unsecured creditors. “Unsecured” means there is no collateral behind it. You are near the end of the breadline in the event of bankruptcy. ETNs aren’t regulated under the aforementioned Investment Company Act of 1940.
While the fundamentals of the issuer are not technically factored into the net asset value (NAV) of the ETN, the issuer matters because a lot of ETNs are “broken products.” That means they aren’t creating or redeeming shares. The NAV of the products is more likely to fluctuate wildly if liquidity problems arise. Liquidity problems? You know, the thing that tends to happen when lots of people run for the door at the same time and are depending on other people to buy a product they don’t want? Yea, that… Not wanting to deal with the potential problems that could arise, Fidelity actually banned its retail clients from taking new positions in certain products earlier this year.
Deutsche Bank, which recently closed nearly a quarter of its German branches, was the issuer on 28 ETNs until it recently closed 8 of them and had another one forcefully delisted because of a lack of assets. If things at Deutsche continue to spiral, owners of the remaining notes may have a hard time finding a buyer for them since suddenly it doesn’t just matter what the index does, it matters what happens to Deutsche Bank. Over half of the assets left in Deutsche Bank ETNs are in a note (FIEG) that was custom created for Fisher Investments, though others can buy it on the open market. This could be another controversy brewing for Ken Fisher, who has experienced a rash of negative publicity in recent years due to poor performance, legal issues and creating “one-size-fits-all” portfolios.
What are your options?
If you are self-directed, don’t buy what you don’t understand. If you are managing all your own money, you’ve declared yourself a professional. That means you are responsible for knowing everything a professional would know.
If you pay for advice, make sure you are working with a competent fee-only financial advisor who owes you a fiduciary duty at all times. If your advisor uses anything that resembles an ETF or ETN, ask them the difference and which you have and why. There are good reasons to use some ETNs, some of the time. If your advisor is clueless, however, he or she may be exposing you to risks neither of you understand.
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