Be careful what you wish for. For all the leveraged fund critics that either do not like or do not understand daily (or monthly) reset of leverage and want a vehicle without path-dependent performance, your wish has come true. However, unless you bought them yesterday, you will not be getting the exact 2x or 3x index exposure you desire. You can’t have everything.
Five new ETNs (exchange-traded notes), dubbed ETN+, from Barclays began trading yesterday (11/18/2009). When Barclays sold their iShares business, it appears that all their marketing and product naming people were also part of the deal. Here are the official names, but they won’t give you any clue as to the leverage employed:
- Long B Leveraged Exchange Traded Notes Linked to the S&P 500® Total Return Index (BXUB)
- Long C Leveraged Exchange Traded Notes Linked to the S&P 500® Total Return Index (BXUC)
- Short B Leveraged Exchange Traded Notes Linked to the Inverse Performance of the S&P 500® Total Return Index (BXDB)
- Short C Leveraged Exchange Traded Notes Linked to the Inverse Performance of the S&P 500® Total Return Index (BXDC)
- Short D Leveraged Exchange Traded Notes Linked to the Inverse Performance of the S&P 500® Total Return Index (BXDD)
Further analysis of the naming reveals no identifiable pattern. For example “Long B” refers to 3x while “Short B” refers to -1x. If you want -3x, then you need to buy the “Short D” note. The two notes with 2x leverage both happen to contain the letter “C” in their name, but this appears to be a random coincidence. Perhaps there is a code-breaker reading this who can help me out.
For the time being, I am going to boycott the official names, and instead, refer to these new products as:
- Barclays S&P 500 3x Long 2009 ETN+ (BXUB)
- Barclays S&P 500 2x Long 2009 ETN+ (BXUC)
- Barclays S&P 500 1x Short 2009 ETN+ (BXDB)
- Barclays S&P 500 2x Short 2009 ETN+ (BXDC)
- Barclays S&P 500 3x Short 2009 ETN+ (BXDD)
I suspect that someone is wondering why my “name” for each ETN contains “2009” when these notes are due to mature in 2014. Since the leverage is never reset in these products, I think it is much more important to know when the leverage was established as opposed to the maturity date. To be more precise, the leverage was probably established at the close on November 17, 2009, the day before they began trading. My guess is that Barclays plans on releasing additional series of these notes, perhaps every year.
Most critics of leveraged funds believe they should perform just the same as if you had bought additional shares on margin. Barclays is moving toward that goal with these new products. However, unless new products are issued every day, the “same as margin” performance cannot be achieved. The reason for that is simple – the leverage level is established at the time of purchase, or in the case of these new ETNs, at the time of creation. The S&P 500 did not finish unchanged yesterday, so if you try to buy any of these ETNs today, tomorrow or next year, your exposure will be different than when issued. Barclays realizes this and calls it the “participation” rate, which they will publish every 15 seconds along with the intraday indicative value.
One of the great features of ETFs with daily or monthly reset of leverage is that you are protected from a total wipeout and protected from losing more than your investment. That same feature is also what causes them to have path-dependent performance over periods longer than their reset interval. Investments that do not reset their leverage must employ other techniques to help mitigate a loss greater than the original investment.
The odds are very high that the S&P 500 will hit a level that is more than 33% higher or lower than it was yesterday, thereby sending the value of one of these notes to zero or lower. Barclays realizes this too and has put in place a stop-loss and liquidation mechanism if the value of any note falls below $10. The 3x long note (BXUB) was issued with an original value of $50, so if the S&P 500 hits 814 (plus adjustments for dividends and fees), anytime in the next five years, then the note will be terminated. That’s about a -26.6% decline from the issue level. Like I said, it’s much more important to know the date the leverage was established than the maturity date.
Fees on these new products are even harder to pinpoint as they do not charge a fixed fee. Instead, they opt to “charge an annualized fee based on notional cash amounts underlying each security (the financing level for Long Notes, and the T-bill amount for Short Notes)…under certain circumstances and in the particular in the case of Barclays ETN+ Notes where the financing level or T-bill amount is a high multiple of the [underlying value], the fees may represent a significant percentage of the [underlying value].”
Don’t get me wrong. I’m not saying these are bad products. I am saying be careful what you wish for. If you think daily reset is too hard to understand, then don’t go jumping into these thinking that all your problems are solved.
You need to understand what you are buying. To start that process, here are links to:
- Barclays’s 11/18/09 press release announcing ETN+
- The BARX website
- Long notes brochure
- Short notes brochure
- ETN+ FAQ
The following background information was taken from the press release…
“We are pleased to offer investors the first exchange traded notes that provide access to leveraged returns in the US equity market. The Barclays ETN+ Notes were designed to provide transparent investment solutions to sophisticated investors who have a strong directional view of the market and, specifically, of the performance of the Index,” said Philippe El-Asmar, Managing Director, Head of Investor Solutions at Barclays Capital. “Today’s launch is the first in a series of leveraged ETNs that we plan to develop and link to other equities indices and asset classes.”
Barclays ETN+ Notes are senior, unsecured, unsubordinated debt securities issued by Barclays Bank PLC. The Notes are designed to provide investors with a new way to access leveraged returns of a market or strategy, less certain costs and fees. The primary features of the Barclays ETN+ Notes are a leveraged return, a fixed maturity date, a stop-loss mechanic resulting in automatic early redemption and an optional redemption feature for holders. The Barclays ETN+ Notes track a fixed multiple of the performance of the underlying index over the term of the notes, before the deduction of certain costs and fees.
Disclosure compliant with FTC 16 CFR Part 255 covering writer, editor, and publisher: No positions in any of the securities mentioned. No positions in any of the companies or ETF sponsors mentioned. No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.