Canada-only ETNs Target Institutions

Risk management and commodities the focus.

April 19, 2012

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story_images_Canada-flagCanada’s ETF market just got bigger. Last Friday the first exchange-traded notes listed solely in Canada started trading. Launched by Barclays Bank PLC, two of them are aimed at helping sophisticated investors and institutions manage risk: the iPath S&P 500 VIX Short-Term Futures CAD Hedged ETN (TSX:VIX) and iPath S&P 500 Dynamic VIX CAD Hedged ETN (TSX:DVX) are both volatility-linked ETNs designed to hedge risk. The third — iPath Pure Beta Crude Oil CAD Hedged ETN (TSX/PBO) – taps investor demand for commodities, offering better exposure to the underlying WTI crude oil commodity than the average futures-based index.

Investors in Canada have long had access to US-based ETNs – the idea behind the Canada-only ETNs based on US indices means investors don’t have to worry about the currency risk.

The three ETNs will tap into the growing Canadian appetite for exchange-traded funds. According to BlackRock, ETFs took in a total of $4.8 billion in new assets in Q1 2012, a 60% jump in the inflow growth rate over 2011.

ETNs also avoid one risk investors have found in the ETF space – tracking error. ETFs have drawn fire over tracking error because some have been unable to exactly replicate the indices they track. The problem stems from diversification issues due to limits on the maximum an ETF can allocate to a single stock. Tracking error isn’t a problem in the ETN space since they’re debt instruments. Investors are paid a set rate of return because they are treated as prepaid contracts. So, at the end of the day, you get exactly what you expect to get…with a few added risks, not the least of which is credit risk. If the issuing company defaults, investors lose their money.

At the end of the day, these new ETNs have a lot to offer Canadian investors who can handle the risks as they seek to hedge other risks (i.e. currency risk). And, at the very least, they show the Canadian ETF space coming into its own.

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