MAKING DIFFICULT-TO-ACCESS

asset classes such as

and

easier to invest in has been one of the biggest developments this year for exchange-traded funds. Barclays, already the leading provider of ETFs thanks to its iShares offerings, is taking the evolution one step further with the rollout of exchange-traded

, or ETNs, that track various commodities.

While ETNs might seem on the surface to be the same as ETFs, especially considering the similar-sounding names and a common issuer, the two are very different animals. Both trade daily on an exchange and can be shorted like stocks, but unlike ETFs, which are typically collateralized by underlying securities, ETNs are unsecured debt issued by Barclays. That means the notes are only good as long as the issuer stays solvent. Granted, Barclays is one of the world's largest financial-services companies, but even the bluest of blue chips can run into trouble. As such, anything that affects the credit rating of Barclays could negatively impact the ETNs. It's an added gamble for commodities investors who are already venturing into a risky asset class.

Barclays currently has three ETNs in its iPath product line that are listed on the New York Stock Exchange. The iPath GSCI Total Return Index ETN, which debuted earlier this summer, tracks the Goldman Sachs Commodity Index. The GSCI is made up of 24 futures contracts and is primarily an energy play with 74% of the portfolio invested in oil and gas. Industrial metals, agriculture, precious metals and livestock contracts fill out the index.

Limiting exposure to energy is the iPath Dow Jones-AIG Commodity Total Return Index ETN, which caps the amount any one commodity group can hold in the portfolio at 33%. At the end of July, this index was comprised of 19 futures contracts: 29% in energy, 23% in industrial metals and 30% in agriculture. The remainder was split between precious metals and livestock.

Barclays launched its latest ETN last month, the iPath Goldman Sachs Crude Oil Total Return Index. It tracks the price of West Texas Intermediate crude oil future contracts. The ETN comes on the heels of the United States Oil Fund, the only ETF to track the price of oil futures. USO began trading in the spring as $70-a-barrel crude attracted the attention of individual investors who didn't want to go through the hassle of opening a futures trading account to get in on the action. Barclays has also registered with the Securities and Exchange Commission 14 additional ETNs to track individual commodities including precious metals and livestock.

For more on tracking errors see last week's ETF Focus, "Keeping Up With the Dow Joneses

"ETNs give you a broad-based index without any rebalancing risk or tracking error to the index," says Philippe El-Asmar, Barclays Capital's head of investor solutions, Americas. "Because ETFs use securities, you shuffle the index when you rebalance its stocks and that introduces tracking error. Barclays guarantees its ETN will give the exact same return as the underlying index, minus expense fees."

While Barclays assumes the index-tracking risk, the cost of that luxury can be high. ETNs currently have an expense ratio of 0.75%. Compare that to the 0.50% charged by the United States Oil Fund.

Another downside relates to the redemption feature of ETNs. While ETNs can be sold daily on the secondary markets or held until maturity, institutional investors that want to redeem blocks of 50,000 units or more directly with Barclays can only do so once a week. ETFs can be redeemed anytime during the trading day.

"For an investor that wants daily liquidity, once a week isn't good enough. I like the ETF structure better," says Ron DeLegge, editor of ETFguide.com, a San Diego-based web site focused on ETFs. "If tracking error is that important to you, then you will go with the ETN. But I believe even if you get a little bit of tracking error, all the other benefits of the ETF wrapping are worth it."

Barclays also says ETNs should be taxed as prepaid contracts tracking an index, thus capital gains or losses will only be recognized upon sale of the ETN. That would make them more tax-efficient than commodity ETFs. Because they don't want to take physical possession of the commodities, the ETFs "roll" the underlying futures contracts, moving into longer-dated contracts to maintain exposure. This creates capital gains that are passed to investors and taxed as 60% long-term gains and 40% short-term gains. Considering the Internal Revenue Service has yet to make a definitive ruling on the tax treatment of ETNs, the tax advantages remain theoretical for now.

Also unlike commodity ETFs, which typically buy contracts on leverage and invest the rest of their cash in interest-bearing Treasury bonds, ETNs don't pay out any dividends or interest. That makes managing taxable events easier, but it also potentially takes money out of investors' pockets. Over the summer, Barclays also launched an ETF to track the GSCI, the iShares GSCI Commodity-Indexed Trust. Since the ETF is expected to earn more than 5% interest annually, that's an important distinction.

"The ETNs should be paying investors for the added default risk, and right now they don't," says Dan Culloton, Morningstar's lead ETF analyst. "These are essentially promises, and even if there is only a slight chance of default it's still there. So, it's possible the market may decide ETNs need to trade at a discount because they offer no compensation for the risk."