If you’re new to investing and looking to diversify your portfolio, you’ve probably come across Exchange Traded Funds (ETFs). But what about their lesser-known cousin, Exchange Traded Notes (ETNs)? Let’s break down what ETNs are, how they work in South Africa, and whether they might be right for your investment journey.
Disclaimer: I am not a financial advisor. This information is for educational purposes only and should not be considered as financial advice. Always do your own research and consider seeking advice from a qualified financial professional before making any investment decisions.
What Exactly Are ETNs?
Exchange Traded Notes are listed debt securities that represent a contractual promise by the issuer to pay investors returns linked to the performance of underlying securities or benchmarks. Think of them as IOUs from banks that track the performance of various assets.
Unlike ETFs, which actually own the underlying assets they track, ETNs are unsecured debt instruments where the issuer promises to pay returns without necessarily investing in those securities or commodities. The issuer (typically a major bank) promises to pay you based on how a particular index, commodity, or basket of securities performs.
How Do ETNs Work in South Africa?
In South Africa, ETNs are traded on the Johannesburg Stock Exchange (JSE) and are listed, traded, and settled in Rands. This makes them accessible to local investors without the complexity of foreign currency transactions.
When you buy an ETN, here’s what happens:
- You purchase the note through your stockbroker or investment platform
- The bank issuer tracks the performance of the underlying benchmark (minus fees)
- You can sell the ETN on the JSE whenever you want, or hold it until maturity
- The issuer promises to pay the amount reflected in the index, minus fees, upon maturity
What Can ETNs Track?
ETNs can track a wide range of benchmarks including interest rates, commodity prices, baskets of shares or bonds, and currencies. In South Africa, popular options include:
Commodities: Precious metals like palladium, platinum, rhodium and gold, as well as other commodities
Global Shares: FNB offers Global ETNs that provide exposure to major international companies like Alphabet, Amazon, Apple, Facebook, Netflix, and Tesla
International Indices: Access to markets that might be difficult to invest in directly as an individual
African Markets: ETNs give access to indices in less liquid markets like African stock markets
Quanto vs Compo: Understanding Your Options
When investing in international shares through ETNs, South African investors typically have two choices:
Quanto ETNs: These track the price of an underlying share without accounting for currency exchange rate fluctuations – if the share goes up 10% in US dollars, the ETN goes up 10% in rands
Compo ETNs: These track both the share price and the exchange rate – if the share goes up 10% in US dollars and the rand weakens by 10%, investors benefit from a 20% move
Key Benefits of ETNs
Affordability: Many ETNs have initially listed at R10, providing very affordable exposure to foreign shares. This low entry point makes global investing accessible to almost anyone.
Diversification: ETNs are useful for providing individual investors with exposure to assets that are difficult to access as individuals
Cost-Effectiveness: It’s more cost-effective to invest in the ETN than in the individual underlying assets
Flexibility: You can invest through a monthly debit order or relatively small one-off contributions
No Exchange Control Impact: Global ETNs do not use individual or corporate allowance, meaning you can invest internationally without affecting your offshore allowance
Important Risks to Consider
While ETNs offer exciting opportunities, they come with specific risks that every investor should understand:
Credit Risk: ETNs have an additional risk compared with ETFs – if the issuer goes bankrupt, the investment might lose value, just as a debt would. This is the most significant difference from ETFs.
Higher Risk Profile: As they involve a higher degree of risk than ETFs, ETNs suit investors with a higher risk tolerance
No Dividends: ETNs tracking indices do not distribute dividends – they only promise to pay what you would have earned in dividends plus any gain on share prices when you disinvest
Concentration Risk: Some ETNs track single commodities or individual shares, meaning less diversification than broad-based ETFs
How to Invest in ETNs
Getting started with ETNs in South Africa is straightforward. You can open a brokerage account with a JSE Equity Market member, open an investment plan with an ETN provider and make a lump sum investment or invest by debit order, or use a platform that allows you to buy ETN products from different issuers.
Major South African banks offering ETNs include:
- FNB (First National Bank)
- Standard Bank
- RMB (Rand Merchant Bank)
- Absa
Are ETNs Right for You?
ETNs can be excellent tools for investors who:
- Want affordable access to global markets
- Seek exposure to commodities or hard-to-access markets
- Have a higher risk tolerance
- Understand and accept the credit risk of the issuing bank
- Want to diversify beyond traditional South African shares and bonds
However, they may not be suitable if you:
- Prefer to own the actual underlying assets
- Have a low risk tolerance
- Are uncomfortable with the credit risk of financial institutions
- Are looking for dividend income (in the case of equity-tracking ETNs)
The Bottom Line
Exchange Traded Notes offer South African investors an innovative way to access global markets, commodities, and diverse asset classes at an affordable entry point. With 77 exchange-traded notes now listed on the JSE, the options continue to expand.
However, it’s crucial to understand the difference between ETNs and ETFs, particularly the credit risk involved with ETNs. While the issuing banks typically have strong balance sheets, this risk cannot be ignored.
As with any investment, do your homework, understand what you’re buying, and consider how ETNs fit into your broader investment strategy. If you’re unsure, speak with a qualified financial advisor who can help you make informed decisions based on your personal circumstances and risk tolerance.
For more information about ETNs in South Africa, visit:
- JSE: www.jse.co.za
- Smart About Money: www.smartaboutmoney.co.za
- FNB Share Investing: www.fnb.co.za/share-investing
- Standard Bank: www.standardbank.co.za