ETFs and ETNs: Knowing What You Own
by Neil Leeson
One of Warren Buffett’s famous quotes that many investors and portfolio managers follow and recite to their followers, “never invest in a business you can’t understand,” can be applied to investing in exchange-traded products.
The nomenclature ETP is rarely used in the popular press or by investors; even Ned Davis Research has an ETF Service. All ETPs are not created equal. There are exchange-traded funds (, exchange-traded notes and unit investment trusts . Many will add open- and closed-end mutual funds to the ETP basket as well. To confuse matters more, many of these vehicles have different structures: grantor trusts, limited partnerships and open-ended 1940 Investment Company Act funds. These are all important considerations when determining the tax implications, tracking error, asset allocation and distribution differences in owning a fund.
To delve into the differences of structures would take much more space than allotted for this article, but I will cover the three main investment companies. Nearly every ETP provider has literature on their website explaining the differences and similarities among products. In addition, there has been a plethora of books, articles and academic literature published on the subject. For the purpose of this article I want to focus on ETFs and ETNs, explaining the basic mechanics of how they trade, and why it is important to know what you own.
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