UWT is an ETN not an ETF

UWT or Velocity Shares 3x Long Crud Oil ETN issued by Citigroup was recently redeemed. The market has been very unkind to leveraged Exchange-Traded Products ("ETPs"). Many of the products have ceased trading. Most have been Exchange Traded Notes ("ETNs") as opposed to Exchange Traded Funds ("ETFs"). See the list HERE.

The big issue with many ETPs, in general, is that they tend to use leverage. Volatility, especially for lengthy periods, and leverage do not mix well. The price fluctuations usually do not match up with the underlying ETP. The predominant factor for this outcome is that the returns are calculated daily as opposed to long-term performance. The net result is that disparities increase over time. However, as discussed below, ETNs can be more problematic.

ETFs are structured like a Closed-End Fund, the investor owns a bucket of stocks and/or bonds or other securities which follows an existing Index, such as the S&P 500. As a shareholder, the investor is the owner of the underlying securities. If an ETF goes bankrupt for some reason, the shareholder will receive some value based on the bucket of securities.

ETNs are different, they do not own anything. ETNs are essentially debt instruments much like a bond. ETNs promise but don't guarantee a return of principal and also promise to follow an index. UWT is owned by Citigroup. It takes the investor's money and provides a return based on Crude Oil performance. However, it also trades on an exchange, like a stock or ETF. As such it is subject to whims of investors buying and selling UWT which controls the price more than any other factor. To be clear, the price of Crude Oil is simply a gauge. Investors in UWT do not own any of the underlying commodities. In fact, all ETN investors have zero ownership in the underlying commodity or securities. If an ETN goes into bankruptcy, the investor has no ownership and is just an unsecured debtor.

A further complicating factor for ETNs is that like bonds, they can be called or essentially shutdown. Unlike a bond, it won't be at par. One feature common to almost all ETNs is something referred to as mandatory redemption. Like UWT, most ETNs have a clause in the prospectus that addresses closure of the investment or redemption of the Note.

These redemptions occur when an ETN's price falls by some percentage factor or below a predetermined price. Its referred to as a mandatory redemption because if certain factors are met, the Note MUST be accelerated. The investor gets some return of principal based on the ravage NAV that triggered the redemption.

Besides redemptions that are mandatory, an ETN prospectus can provide for an elective redemption because it is in the best interest of the ETN. That is what happened to UWT and its counter-part DWT which is an inverse or short version of UWT. Believe it or not, these redemptions are generally better for the investor as they provide better terms than mandatory redemptions. In the case of UWT, the redemption was based on a period of five days averaged out. This happened before the mandatory redemption kicked in. UWT's and DWT's redemption amounts will be based on their values over a five-day unwinding period. It should be noted that the average is based on the price of the ETN during this five day period. It is not based on the price of Crude Oil or the attendant underlying security/commodity. Many UWT investors complained that during these five days there were positive spikes in Crude, it just did not correlate with the price of UWT. The price of UWT was more specifically based on buyers of UWT. UWT investors never owned Crude Oil.

Believe it or not, redemptions are not the worse thing can happen to investors. The worst is delisting. Redemptions are in place to prevent that from happening. If its de-listed, the ETP is not closed nor bankrupt. It exists but is completely illiquid. Usually, the investment falls close to zero before it delisted. This fact is not much of a consolation for UWT investors, many of whom did not fully understand the investment they were in nor fully appreciate the risks. There may not be much recourse if you picked UWT yourself at a self-directed brokerage account. Exceptions may apply. However, if UWT was recommended to you by a financial advisor or stockbroker, you may have recourse.

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