Market wrappers: What is really in the box

On the stock market, many products are boxes. You do not buy a thing, you buy packaging. The question is always: what is inside?

The best-known box is the ETF. A basket of shares or bonds, listed like a single share.

You buy and sell it continuously, all day long, at the current price. And the basket really belongs to you.

If the company managing the ETF goes bust, the securities in the basket are protected, kept separate from its accounts.

The ETN looks like an ETF. Same three-letter name, same listing. But inside, there is no basket.

There is a promise. A bank commits to paying you the performance of an index. It is a debt of the bank.

If the bank falls, the promise falls with it. You become one creditor among others.

In February two thousand eighteen, an ETN betting on calm markets collapsed in a single day. The issuer then closed it.

Third box: the MBS. Home loans, bundled by the thousand, then resold as a bond.

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Say one thousand loans of two hundred thousand euros. Two hundred million in repayments, which become securities.

The bank that lent no longer keeps the risk. It sells it. That is securitisation.

The basket is cut into tranches, like a building. Repayments fill the top floor first.

Losses climb from the bottom. The bottom tranche pays more interest, because it takes the first defaults.

For the example: a basket of one hundred million, a bottom tranche of ten million. Five million of losses: it loses half.

Fifteen million of losses: it is wiped out, and the next tranche loses five million. The top feels nothing.

In two thousand seven, defaults on subprime loans rose far higher than expected. Tranches rated safe lost money.

The CLO follows the same recipe, with other ingredients: loans to companies that are already heavily indebted.

Same cutting into tranches. Same promise: diversification protects the top. As long as the defaults do not all come together.

Last box, the strangest: the SPAC. A listed company with no factory, no customers, no product.

It raises money on the stock market, usually at ten dollars a share. Then it looks for a company to buy.

It has a deadline, often two years. If it finds nothing, it returns the money. If it does, the target enters the market through the back door.

In two thousand twenty and two thousand twenty-one, hundreds of SPACs listed. Many of their targets then fell sharply.

All these boxes have one thing in common: the label is not enough. You need to know what is inside, and who is promising it.

A basket you own, a bank's promise, sliced-up loans, an empty shell. Four very different risks.