The period after the financial crisis of 2008 was marked by a strong recovery in the financial and stock markets. However, it also saw the rise of complex securities that promised to deliver more growth than the traditional types of securities. Exchange Traded Notes or ETNs are among the complex securities that have been gaining popularity in the last few years. This is particularly due to the fact that they offer significantly higher returns than regular securities. They delivered significant growth in the last ten years or so. This is why they attracted so many investors.
UBS ETRACs has several different ETNS that track various indexes and strategies. An example is UBS ETRACS Alerian MLP Index ETN that was worth more than $35 in 2015, dropped to $15 in 2019 and hit $5 in the coronavirus crash to bounce up to $10. Investors and traders need to fully understand the massive risks before investing in ETNS.
Here are five other popular ETNs:
- iPath Dow Jones-UBS Commodity Index Total Return ETN (DJP)
- iPath MSCI India ETN (INP)
- iPath S&P 500 VIX Short-Term Futures ETN (VXX)
- JP Morgan Alerian MLP Index Exchange Traded Notes (AMJ)
- iPath S&P GSCI Crude Oil Total Return Index ETN (OIL)
ETNs collapsed in a matter of days leading to huge losses for investors
The coronavirus rapidly caused a huge economic downturn as businesses shut down, stocks plummeted, and complex securities were among the investment types that took a huge hit. They had collapsed in just two weeks, and investors lost a lot of money. One of the investors named William Mark, an engineer, is among the people that had invested in ETNs.
Mark saw ETNs as an opportunity to make a quick recovery after the 2008 financial crisis. He initially invested some cash in ETNs, which gave him 18% annual dividends. Seeing this, he decided to add an extra investment of $800,000. Unfortunately, when the coronavirus happened, he lost his investment as the ENTs collapsed. The 67-year-old went from earning handsome returns to bankruptcy in a matter of two weeks.
Brokerages and banks had previously marketed the market instruments as some of the robust investment options available where investors could enjoy steady returns. They proved to deliver strong returns just as had been marketed. However, the problem came when the markets faced an economic downturn, which was fueled by the COVID-19 pandemic.
Does the collapse of ETNs mean that they are too risky?
Looking back at the historical performance of complex securities in the past few years reveals that they performed well and delivered strong, consistent returns. That period was also characterized by sound growth, and markets thrived, so it is no surprise that the ETNs delivered as banks and investment firms had promised.
Where did things go wrong? If you observe the performance of securities pre-2008, you will realize that there was a similar pattern. Stable growth before economic downturn. The only difference is that back then, the economic crisis was triggered by deregulation in the financial industry. The current economic crisis was caused by economic downturn as normal business activities were halted or disrupted by the coronavirus as governments implemented stay-at-home directives. Businesses shut down as part of the government directives, aiming to prevent the spread of the virus.
Amidst all that, the markets took a hit, and they crumbled. This exposed the risk factor in complex securities. However, higher risk does not necessarily mean that one should avoid such investments. If they proved anything, they work during times of relative economic stability and do not work during tough economic times.
What could investors have done?
Investors should educate themselves more on the type of investments that they get themselves into. Understanding your investment option will allow you to understand how to maneuver the risk. For example, any investor that had a deep understanding of complex securities and their associated risks would have been in a better position to pull their money out when the markets started to show signs of volatility.
However, investors that were sold these types of investment by financial advisors may have options to recover losses. Recently, Haselkorn & Thibaut (InvestmentFraudLawyers.com) has opened an investigation into losses by investors to file claims against the brokerage firms that sold them.
There were signs of tough times ahead since 2018 when market experts started to blow the whistle on the overstretched economic growth. This meant that the economy was becoming more susceptible to huge crush in case an economic crash was to happen. This would have been a good sign for investors to shift their money into low-risk investments.
Ruchi has an Accounting and Graduate Degree in Business from the International School and Business and Media. She is exceptionally skilled in financial databases like Bloomberg, ThomsonOne,Datastream, CapitalIQ, and Factiva. Her focus at AlphaBetaStock.com is research breaking stocks and investment stories.