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Summary

  • Getting excited about MORL's dividend is a mistake. It will not last.
  • I recommend a safer income investment in my conclusion.
  • MORL is not guaranteed by any third party.

From the UBS web site:

The ETRACS Monthly Pay 2xLeveraged Mortgage REIT ETN (NYSEARCA:MORL) is an exchange-traded note linked to the monthly compounded 2x leveraged performance of the Market Vectors Global Mortgage REITs Index, reduced by the Accrued Fees. MORL is listed on the NYSE Arca exchange, is denominated in USD, and pays a USD-denominated variable monthly coupon linked to two times the cash distributions, if any, on the Index constituents, less any withholding taxes.

Uncertain tax treatment -- Significant aspects of the tax treatment of the Securities are uncertain. You should consult your own tax advisor about your own tax situation."

UBS priced MORL at the close of 10/16/2012. The actual first trading day was 10/17/2012. It opened at $25. The next dividend monthly payment is $0.9642 which translates into an annual yield of 18.75%. Exchange Traded Notes (ETNs) are distinct from Exchange Traded Funds (ETFs). ETNs are debt instruments backed by the credit of the issuer and as such bear inherent credit risk. ETNs are not generally appropriate for the average investor.

MORL Is Unique

Monthly compounded 2x leveraged exposure to the Market Vectors Global Mortgage REITs Index, less fees. That makes it the only exchange-traded product with leveraged exposure to a mortgage REIT index offered on U.S. exchanges.

My Viewpoint

The 2x leveraged ETNs are trading vehicles. They are not meant for a buy and hold strategy. They are not suitable for a long-term investor. They are specifically designed to be used by active traders. Some might argue the following points to make their case for safety:

  • MORL rebalances monthly not daily.
  • MORL's dividends are high enough to make it a safer buy and hold then other ETNs.

In my opinion, the monthly rebalancing and the current 18.5% + yield will not save MORL from a large decrease in share price that will not recover.

I made the comment below here at Seeking Alpha regarding MORL:

" I have seen 2x leveraged index products drop 30% after the index dropped 10%. So it dropped 3x even though it was only supposed to drop 2x. Does anyone know for sure, that if the mREIT sector dropped 10% in one day, MORL would not drop 25%-30% that same day"?

No one responded to my above comment.

Here is some simple math to consider. This is my main point regarding the reasons MORL will not recover over a long period of time.

The index starts at 100, MORL starts at 100
The index drops 25% which is supposed to cause a concurrent drop of 50% to MORL.
So the index is now 75 and MORL is 50.
The index increases 33.3% which is supposed to cause a concurrent increase in MORL of 66.7%
So the index is back to 100 and MORL is at 83.3

The index did not move, but because of volatility and the mathematical consequences of this product, MORL has lost 16.7% of its value

I personally believe that the high yield from MORL is truly chasing yield that will ultimately lead to a poor outcome.

I have read many articles and comments here at Seeking Alpha questioning a high income strategy. I feel their concerns are misplaced. They question the yields of well run companies with excellent track records, yet they miss the truly risky high yield investments, like MORL. I read several comments from SA members stating that they have small positions in MORL and other leveraged ETNs/ETFs. Most investors comments regarding MORL allocation stated that it was a small percentage of their portfolio. If that is the case, then they will not be exposed to any major losses. However, some might get carried away and invest more then they can afford to lose. I know that many Seeking Alpha readers do not comment and therefore they might have larger allocations of MORL in their portfolio. One reason for this article is to warn those investors and anyone else who is not aware of the real risks and potential large losses that can occur from owning MORL.

UBS (documents regarding MORL from UBS's web site and fact sheet) -- Correlation and compounding Risk: A number of factors may affect the ETNs' ability to achieve a high degree of correlation with the performance of the Index, and there can be no guarantee that the ETNs will achieve a high degree of correlation. Because the Current Principal Amount is reset monthly, you will be exposed to compounding of monthly returns. As a result, the performance of the ETNs for periods greater than one month is likely to be either greater than or less than the Index performance times the leverage factor of two, before accounting for Accrued Fees and the Redemption Fee, if any. In particular, significant negative monthly performances of your ETNs may not be offset by subsequent positive monthly performances of equal magnitude.

Credit of Issuer: The ETNs are senior unsecured debt obligations of the issuer, UBS, and are not, either directly or indirectly, an obligation of or guaranteed by any third party. Any payment to be made on the ETNs, including any payment at maturity or call, or upon acceleration or upon early redemption, depends on the ability of UBS to satisfy its obligations as they come due. As a result, the actual and perceived creditworthiness of UBS will affect the market value, if any, of the ETNs prior to maturity or call, or upon acceleration or upon early redemption. In addition, in the event UBS were to default on its obligations, you may not receive any amounts owed to you under the terms of the ETNs.

There are uncertainties regarding the Index because of its limited performance history: The Index was first calculated on Aug. 4, 2011, and therefore has no performance history prior to that date. Because the Index has no history prior to Aug. 4, 2011, little or no historical information will be available for you to consider in making an independent investigation of the Index performance, which may make it difficult for you to make an informed decision with respect to an investment in the ETN.

In the event the indicative value for any series of the Securities on any Trading Day equals $5.00 or less

or decreases 60% in value from the closing indicative value of that series of the Securities on the previous

Monthly Valuation Date, all issued and outstanding Securities of that series will be automatically

accelerated and mandatorily redeemed by UBS and holders of that series of Securities will receive the

Acceleration Amount as determined by the Calculation Agent as described herein. The Acceleration

Amount you receive on the Acceleration Settlement Date may be significantly less than $5.00 per Security

and may be zero if the level of the Index continues to decrease during one or more Trading Days during

the applicable Measurement Period. As a result, depending on the level of the Index on such Trading

Day, you may lose some or all of your investment. The Securities of any series will be automatically

accelerated and redeemed even if the indicative value on that Trading Day or any subsequent Trading

Day would exceed $5.00 or increases from the -60% level, as compared to the previous Monthly

Valuation Date. High volatility and/or unexpected market conditions could result in significant

movements in the level of the relevant Index, which, in turn, may trigger the automatic acceleration and

mandatory redemption of the Securities.

To see the UBS documentation, I have provided a link here: UBS is the issuer and manager of MORL. Click the related documents when you arrive at UBS's website, which you can find in the lower right hand corner of the page.

Conclusion

I am convinced when MORL has a huge sell off, the price decline will not be a temporary one. MORL will not recover. I believe they will do a reverse split in order to make the share price higher. It will provide the illusion of not losing significant value to new investors. An example of a reverse split would be as follows: If MORL was trading at $8, they would do a 3-1 reverse split and the price would reset at $24. The shareholders who owned MORL prior to the reverse split would have their shares decreased to 1/3 of its prior value.

Liquidity is not very good. When high volume selling starts (panic selling), the exits will be too crowded to get out without investors getting hurt. The last 10 day average volume was 428,117 shares. This is truly chasing yield and only problems can arise from doing so. The dividend yield is " too good to be true."

My success has been due mainly to seeing things the majority of others miss and luck. My point here is that many see or assign meanings to concepts incorrectly. One example of this would be that chasing high yield = poor results. The majority interpret that to mean anything that has a high yield (7%+) is risky. There are always exceptions, and if one does their due diligence they have a higher probability of success in finding them. Investing in what most would consider a risky high yield stock may in fact not be as risky as perceived. This is due to a lack of knowledge by the majority of investors. However, the concept, of chasing high yield = poor results is not without merit. To me it clearly applies to MORL. Of course, there are many other stocks, ETN's/ETF's and other high yield investments that would fit into the truly risky category.

I believe the high yield entities that are not nearly as risky as perceived are the diamonds in the rough. I see American Capital Agency (NASDAQ:AGNC) as a diamond in the rough. Unlike MORL, AGNC is guaranteed by GSE's. It is an investment in the mREIT sector that has a high yield. It is not as risky as perceived, in my opinion. The book value can be determined and used for entry and exit points.

I believe AGNC it is a much safer income investment than MORL. My article on AGNC explains why it is a good investment if you have the right mindset: "The Mindset Needed To Be A Successful American Capital Agency Investor."

In my opinion, the MORL dividend will fluctuate over time. However, the overall performance will be poor if held for a long time frame.

Disclosure: The author is long AGNC. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Source: MORL Is A 'Too Good To Be True' Investment