Unlike exchange-traded funds (“ETFs”) and mutual funds, which are legally structured as stand-alone entities, exchange-traded notes (“ETNs”) are debt obligations of the issuer. What is more, they are “unsecured” debt obligations without any type of collateral. Therefore, ETNs carry an additional risk, a risk that would be realized if the issuer were to default or declare bankruptcy.
This risk was overlooked in the early days of ETNs for a couple of reasons: (1) Such a default had never happened, and (2) the issuers were banks that most investors considered to be “too big to fail.” Then along came the financial crisis and the collapse of Lehman Brothers. Lehman was the issuer of three U.S.-listed ETNs under the “Opta” brand, including the Opta S&P Private Equity ETN (former ticker PPE). When Lehman declared bankruptcy eight years ago, owners of the three Opta ETNs were left holding the bag.
Today, Deutsche Bank (DB) is the issuer of 20 ETNs currently offered to U.S. investors, although only 19 of them are listed for trading. Over the past week or so, legitimate concerns about the financial viability of DB have surfaced. Its stock has plunged 19% in eight trading days, surpassing the 2008 financial crisis low. The company faced credit rating downgrades earlier this year, the U.S. Justice Department is seeking a $14 billion settlement related to mortgage-securities investigations, and the German government is getting nervous. DB probably falls into the “too big to fail” bucket among European financial institutions, but what if it’s not? If DB has borrowed money from you, then you should be concerned. If you own DB ETNs, then DB has borrowed money from you, and your loan to DB is not secured with any collateral.
Your best recourse at this time is to sell your DB ETNs before such a risk materializes. On August 31, DB was the issuer behind 28 ETN listings on U.S. markets. DB “called” eight of them for redemption, with their last day of trading occurring on September 19. Additionally, the NYSE forced the delisting of the DB Base Metals Long ETN (BDG) after the market closed on September 16 because it had less than $400,000 of assets. Unfortunately, DB has not announced any plans or intentions of redeeming the BDG notes and returning the money to the noteholders. Instead, owners will have to find a buyer in the unlisted over-the-counter market for ETNs. Good luck with that.
It should be relatively easy to dispose any of the remaining 19 listed ETNs. Together, they hold about $727 million in assets, with nearly half ($351 million) in the Deutsche Bank FI Enhanced Global HY ETN (FIEG). This ETN was a custom creation for Fisher Investments, and I presume that Fisher then placed the shares into its clients’ accounts. If so, then Fisher controls the decision of what risk mitigation steps to take regarding these particular ETNs.
The next largest DB ETN is the DB Gold Double Long ETN (DGP) with $144 million in assets. I would recommend that owners of this product replace it with the ProShares Ultra Gold ETF (UGL), which also offers 200% exposure to gold bullion but in a much safer ETF wrapper. Next in terms of assets is the DB Crude Oil Double Short ETN (DTO) with $70 million. Here, the ProShares UltraShort Bloomberg Crude Oil ETF (SCO) offers safer exposure. The only drawback to the replacement ETFs I have suggested is that they issue K-1 statements instead of 1099s for tax reporting. For investors that are used to dealing with K-1s, it is not big deal, but competitors and the financial media have done their best to scare investors.
There are suitable replacements for many of the other DB ETNs, and resources such as the ETF Field Guide can help you locate and evaluate them. By the way, all of the DB ETNs are “broken products” and are identified as such in the ETF Field Guide. A broken product is one where the creation mechanism is not functioning. This makes it difficult to impossible for market makers to keep the trading prices in line with the underlying net asset values. Consequently, it is imperative that you use a limit order when selling your DB ETNs. The good news is that the credit worthiness of the issuer is not a factor in calculating the net asset values of ETNs. Therefore, if you can sell your DB ETNs at a price close to the net asset value, then you should be getting a fair deal.
Disclosure: Author has no positions in any of the securities mentioned and no positions in any of the companies or ETF sponsors mentioned. No income, revenue, or other compensation (either directly or indirectly) is received from, or on behalf of, any of the companies or ETF sponsors mentioned.