This article was released to members of the Cambridge Income Laboratory 1 month ago.
For the inaugural edition of the ETRACS 2x Leveraged ETN Snapshot, please see here. Data are taken from the close of May 9th, 2017. Previous articles on the Snapshot can be searched using the keyword “ciletn”.
Fund additions, closures, or notable adjustments
No new ETRACS 2x fund additions or closures.
(For those interested in alternative income ETNs, Credit Suisse has a new ETN launched this month that executes the covered call strategy on oil: the X-Links™ Crude Oil Shares Covered Call ETN (NASDAQ:USOI). This is similar to the gold (NASDAQ:GLDI) and silver (NASDAQ:SLVO) covered call ETNs that I’ve written about previously.)
The following table shows the ETNs in the ETRACS 2x leveraged line-up, with the fund name, ticker inception date, assets under management, average volume, yield, expense ratio excluding 3-month LIBOR, adjusted total expense ratio including LIBOR, and the corresponding 1x fund (where available). Yield and expense ratio statistics are discussed further in their separate sections below.
|Fund||Ticker||Inception||Assets / m||Volume / k||Yield||TER||Adjusted TER||1x fund|
|Monthly Reset 2xLeveraged S&P 500 Total Return ETN||(NYSEARCA:SPLX)||3/2014||6.7||1.2||0.00%||1.25%||1.21%||(NYSEARCA:SPY)|
|Monthly Pay 2xLeveraged S&P Dividend ETN||(NYSEARCA:SDYL)||5/2012||17.2||2.5||4.94%||0.70%||0.94%||(NYSEARCA:SDY)|
|Monthly Pay 2xLeveraged Dow Jones Select Dividend Index ETN||(NYSEARCA:DVYL)||5/2012||35.0||4.7||6.61%||0.75%||0.96%||(NYSEARCA:DVY)|
|Monthly Pay 2xLeveraged US High Dividend Low Volatility ETN||(NYSEARCA:HDLV)||9/2014||22.0||8.0||9.93%||1.45%||1.31%|
|Monthly Pay 2xLeveraged US Small Cap High Dividend ETN||(NYSEARCA:SMHD)||3/2015||25.0||19.3||13.93%||1.65%||1.41%|
|Monthly Reset 2xLeveraged ISE Exclusively Homebuilders ETN||(NYSEARCA:HOML)||3/2015||5.5||3.1||1.65%||1.41%|
|Monthly Pay 2xLeveraged Wells Fargo MLP Ex-Energy ETN||(NYSEARCA:LMLP)||6/2014||24.9||30.0||10.79%||1.45%||1.31%||(NYSEARCA:FMLP)|
|Monthly Pay 2xLeveraged MSCI US REIT Index ETN||(NYSEARCA:LRET)||5/2015||6.9||4.9||8.18%||1.65%||1.41%||(NYSEARCA:VNQ)|
|Monthly Pay 2xLeveraged Mortgage REIT ETN||(NYSEARCA:MORL)||10/2012||368.0||306.5||17.83%||0.80%||0.99%||(NYSEARCA:MORT)|
|Monthly Pay 2xLeveraged Mortgage REIT ETN Series B||(NYSEARCA:MRRL)||10/2015||17.3||4.8||17.83%||0.80%||0.99%|
|2xMonthly Leveraged Alerian MLP Infrastructure Index ETN Series B||(NYSEARCA:MLPQ)||7/2010||50.7||5.5||0.00%||1.65%||1.41%||(NYSEARCA:MLPI), (NYSEARCA:AMLP)|
|2xMonthly Leveraged S&P MLP Index ETN Series B||(NYSEARCA:MLPZ)||2/2016||67.5||1.1||0.00%||1.95%||1.56%||(NYSEARCA:IMLP)|
|2xLeveraged Long Wells Fargo Business Development Company Index ETN||(NYSEARCA:BDCL)||5/2011||278.4||152.2||13.84%||0.85%||1.01%||(NYSEARCA:BDCS)|
|2xLeveraged Long Wells Fargo Business Development Company Index ETN Series B||(NYSEMKT:LBDC)||10/2015||21.1||2.0||13.84%||0.85%||1.01%|
|Monthly Pay 2xLeveraged Closed-End Fund ETN||(NYSEARCA:CEFL)||12/2013||271.4||208.5||17.21%||0.90%||1.04%||(NYSEARCA:YYY)|
|Monthly Pay 2xLeveraged Diversified High Income ETN||(NYSEARCA:DVHL)||11/2013||13.2||12.1||13.19%||1.25%||1.21%|
*Excludes 3-month libor (currently 1.17%).
Assets and volume
The chart below shows the assets under management and the average volume for all of the 2x ETNs. We can see that MORL is the largest of the 2x ETNs, followed by BDCL. MORL is also the most actively-traded 2x ETN, while the second is CEFL.
Note that several of the ETNs are thinly traded. For those illiquid ETNs, it is recommended to use limit orders to ensure that the transaction is executed at an acceptable price. Moreover, it is highly recommended to check the indicative price of an ETN, available on the UBS ETRACS website (e.g. here for CEFL), before buying or selling the low-volume ETNs. This is because financial websites or brokers often quote the last-traded price, which can deviate significantly from the NAV (technically, “indicative value” for the ETNs) for the thinly traded ETNs.
One of the major attractions of the 2x leveraged ETNs is their often mouth-wateringly high yields. The yields (trailing 12 months) of the funds are displayed graphically below, arranged in order of smallest to largest. Note that SPLX and HOMX are total return funds, and hence pay zero distributions. This month, we have a reversal in the order of the top 2 highest-yielding ETNs, with MORL/MRRL in first place at 17.83% followed by CEFL in second at 17.21%. All of the ETNs pay monthly except for BDCL/LBDC, MLPQ and MLPZ which pay quarterly (and except for SPLX and HOMX which pay no distributions at all).
Dividend growth rate
Investors might be interested in whether or not the 2x ETNs have been able to grow their distributions. The following chart shows the 1-year DGR and 3-year (annualized) DGR for the 2x ETNs, where available. Note that these are calendar year DGRs, for example, the 1-year DGR represents the distribution increase from 2015 to 2016.
We can see that HDLV, SDYL and DVYL have been able to increase their distributions over 1-year periods, while five other ETNs saw their distributions decline. For the ETNs that have been in existence since the start of 2013, DVYL and SDYL have increased their distributions while MORL and BDCL have had their distributions reduced.
It should be remembered that the distributions of the 2x ETNs are not only affected by the yield of the underlying holdings, but also changes in price of the ETNs. This is because the ETNs are 2x leveraged. Hence, increases in the price of the ETNs will boost their distributions, and vice versa.
Regarding the expense ratios, UBS engages in the (rather dubious, in my opinion) practice of hiding their financing spread within their pricing supplement, which makes their headline management fee (known as “tracking rate”) look lower. For example, SDYL has an annual tracking rate of 0.30%, a figure that is displayed prominently on the fund’s website, but you have to dig into the pricing supplement to see that you are being charged an additional 0.40% in financing spread. This means that the total financing rate will be 0.40% + 3-month LIBOR (currently 1.17%). Adding all three fees together gives a total expense ratio [TER] of 0.30% (tracking rate) + 0.40% (financing spread) + 1.17% (3-month LIBOR) = 1.87%.
However, remember that these ETNs are 2x leveraged. Thus, I devised an “adjusted TER” that takes into account both the current LIBOR rate, and the leverage of the fund, which can be achieved by simply dividing the total expense ratio (including LIBOR) by 2. I believe that this value is more useful when one is trying to compare the expense ratio of the 2x ETNs versus unleveraged funds. In fact, with some of the adjusted TERs being lower than the expense ratios for unleveraged 1x funds, it might be able to juice your portfolio by up to nearly 1% a year by synthetically replicating a 1x position (as described in “Build Your Own Leveraged ETF (ETRACS Edition)“).
The following chart shows the expense ratio (excluding LIBOR) and the adjusted TER of the funds, arranged from lowest to highest. MLPZ has the highest expense ratio (excluding LIBOR) of 1.95%, and its adjusted TER comes out to 1.56%. SDYL has the lowest expense ratio (excluding LIBOR) of 0.70%, and its adjusted TER comes out to 0.94%.
Position within 52-week trading range
I also calculated the position of the stock price of each 2x ETN as a function of their 52-week trading range which is a metric I have found to be quite useful when making buy or sell decisions. As a value investor, I am more inclined to buy a stock when its price is close to its 52-week low. Conversely, I am reluctant to buy stocks when their prices are close to their 52-week highs (of course, momentum investors will disagree).
In the above chart, 0% on the x-axis indicates the midpoint of the 52-week trading range. The -50% position indicates the 52-week low while +50% indicates the 52-week high. Note that some of these values may be inaccurate due to the low liquidity of some of the ETNs.
We can see that a number of the ETNs have fallen off moderately from their highs this month. Notably, LRET, MLPQ, HDLV and MLPZ are all trading closer to their 52-week lows than their 52-week highs, and might represent more attractive value candidates from that regard.
The following chart shows the recent performance of the suite of 2x ETNs, in terms of total return [TR]. 1-year, 3-year and 5-year TR values are given were available, with time periods longer than 1 year being annualized.
We can see from the chart above that the 2x ETNs have generally had superb 1-year TR performances. In particular, HOML, SMHD, MORL/MRRL, BDCL/LDBC, and LMLP have all bested SPLX, the 2x version of the S&P 500. SMHD had the highest 1-year return of 75% and LRET the lowest at -4%.
Reminder about Series B ETNs
In October 2015, UBS launched six new “Series B” ETNs, four of which were 2x leveraged (MLPQ, MLPZ, MRRL, LBDC). The main difference between the original “Series A” ETNs and the Series B ETNs is that the former are co-guaranteed by both UBS AG and UBS Switzerland AG, whereas the newer the latter are guaranteed by UBS AG only. In theory, this should make the Series B ETNs less valuable than the Series A, since the former are solely guaranteed by UBS AG. However, it is hard to imagine a scenario where UBS AG goes under and its subsidiary, UBS Switzerland AG (and by extension the Series A notes) remains unscathed.
In the same announcement, UBS also stated that they do not intend to issue any new notes in any of its existing Series A ETNs. While this could in theory make those ETNs “broken products”, a few simple guidelines could help prevent investors from going astray. First, this “does not affect the terms of the outstanding Series A ETRACS ETNs… including the right of noteholders to require UBS AG to redeem their notes on the terms”, meaning that if the ETNs were to deviate significantly below their NAV, large players could buy the notes on the open market and have UBS redeem them (in blocks of 50,000) at their NAV. This arbitrage potential should act as a driving force to push the price of the ETN back up towards its NAV.
On the other hand, if the notes were to deviate significantly above their NAV (say >10%), then… what are you waiting for? Sell the notes right now on the open market and buy them back later when the price falls back to its NAV. This also serves to remind that one should always check the indicative value of the ETNs on the UBS ETRACS website before buying any fund. To my knowledge, despite UBS announcing suspension of issuance of new Series A ETN shares, none of the ETNs have ever traded significantly above (>10% ) their NAV for any sustained period time.
Reminder on leverage
An interesting feature of the ETRACS 2x leveraged ETNs is that their leverage resets monthly rather than daily, which is the norm for most leveraged funds in the market. It is well known that decay or slippage in leveraged funds will occur when the underlying index is volatile with no net change over a period of time. By resetting monthly rather than daily, the decay of the ETRACS ETNs might be somewhat mitigated.
Seeking Alpha author Dane Van Domelen has conducted both theoretical and empirical research into the performance of leveraged funds. His research showed that in most cases, the decay is not as serious as is often initially thought to be. My own research on the live performance of the 2x ETNs showed that monthly resetting has generally helped rather than hurt performance.
Moreover, the 2x ETNs charge a finance cost (3-month LIBOR plus a variable financing spread) to maintain their 2x leverage. Due to prevailing low interest rates, the finance charge is currently relatively low, but this could change when/if interest rates rise in the future. Still, the financing rates charged to these ETNs are still much lower than what the majority of retail investors would be able to access from their brokers. This means that from an expense ratio point of view, it would usually be better to buy the leveraged fund than to try and replicate it yourself with a margin loan from your broker.
Reminder on ETN structure
It should be noted that investors in the 2x ETNs are subject to credit risk from the fund sponsor, in this case UBS. If UBS were to go bankrupt, the ETNs will likely become worthless. Professor Lance Brofman has argued that the risk of ETN investors losing money due to UBS going bankrupt is, barring an overnight collapse, minimal because the notes can always be redeemed (in 50,000 share blocks) at NAV.
Moreover, since ETNs are debt instruments, their distributions are considered as coupon payments rather than as dividends. Distributions from ETNs are therefore treated as interest tax-wise and subjected to the ordinary income tax rate.
Is there any other data that you would like to be included in the ETRACS 2x leveraged ETN Snapshot? If so please let me know!
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Disclosure: I am/we are long BDCL, HDLV.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.