23 Mar 2009, Mark Pengelly, Risk magazine
Gold is typically a safe haven in times of financial distress, noted Dan Draper, London-based global head of exchange-traded funds (ETFs) at Lyxor. But investors wary about the market in general might also be unwilling to take the counterparty risk associated with ETNs. Unlike ETFs, ETNs constitute a senior unsecured debt obligation of the issuer - in other words, a bond.
While ETNs offer exchange-traded liquidity and the ability to redeem at par, their structure means that, if the issuer defaults, investors may be left waiting in a lengthy queue of unsecured creditors to get any of their money back. As with other structured products, this consideration has weighed more heavily than ever on the minds of investors following the bankruptcy of Lehman Brothers, which affected the bank's suite of US ETNs.
To counter this, the Lyxor product will be 100% collateralised by high-quality credit assets held in a special-purpose vehicle, which will contain a mix of eurozone government bonds and highly rated euro government bond funds.
"What we're trying to do is add an extra layer of security. You have a strong issuer in Société Générale, but in addition to that there's 100% collateral with AAA-rated funds or government bonds from the eurozone. So in the case of a bankruptcy like Lehman Brothers, there's collateral that's ring-fenced and available to the end investor," said Draper.
With recourse to a collection of underlying assets, the product looks similar to an ETF. But unlike an ETF, the product does not have the potential to suffer from a divergence in performance between the fund's assets and the index it targets - otherwise known as tracking error.
See also: All shook up