Implicit leverage: Can accrued fees cause levered ETN returns?

Abstract

Exchange Traded Notes (ETNs) are unsecured debt obligations backed by the credit quality of the issuing bank. These investments are designed to provide the return of an index. We show how different formulae for calculating ETN indicative values result in different returns. Specifically, the practice of accruing the management fee creates time-varying leverage relative to the index. For the commodity index we study this leverage reaches a maximum of 23.44%. Subsequently created ETNs that do not accrue managements fees track their index more closely. However, relative to some of their non-levered counterparts implicitly levered ETNs experience higher average trading volume.