Barclays Launches BuyWrite Exchange-Traded Note, Hopes for Tax Efficiency

Barclays Global Investors expanded its iPath family of exchange-traded notes (ETNs) with the launch of the iPath CBOE S&P 500 BuyWrite Index ETN (BWV). The new products tracks—of course—the CBOE S&P 500 BuyWrite Index.

The CBOE index was launched in 2002 and represents the performance of a buy-write investment strategy as applied to the S&P 500. In a buy-write strategy, an investor buys stocks and then writes covered call options on them. The funds make money from the premiums on the calls, which in most cases, is paid out on a quarterly basis. Currently, closed-end buywrite funds, like the Eaton Vance Tax-Managed BuyWrite Fund (ETB), are yielding around 9%.

The scheme usually does best in sideways markets, and offers some protection against downward markets; however, it sacrifices performance when the market is on an upswing.

BuyWrite Interest
Although buy-write—also known as “covered call”—strategies are nothing new, they are not quite mainstream. The strategy can seem too complex to the average retail investor, and will dramatically lag the market during strong bull markets. However, given the choppy markets of the last few years, buy-write strategies have regained a significant foothold.

Mainly, the strategy is available through closed-end funds, although late last year, the CBOE launched futures on the CBOE S&P 500 BuyWrite Index, and firms such as Citigroup and Merrill Lynch have also introduced notes on the index.

A flurry of closed-end funds were launched beginning in 2004, when the market entered a somewhat neutral performance period. The funds range widely. IQ Investment Advisors manages the closed-end S&P 500 Covered Call Fund (BEO), which tracks the same CBOE BuyWrite Index as the new closed end fund. Most closed-end buy-write funds, however, are actively managed. Fund manager Eaton Vance is probably the leader in the space, offering five buy-write funds that collectively hold more than $5 billion in assets. Other companies with closed-end funds include Nuveen Investments, BlackRock, and First Trust.

Why An ETN?
BWV offers a new angle on the buy-write strategy. The iPath ETNs are intended to provide investors exposure to “difficult-to-reach market sectors and strategies,” according to BGI’s Web site. The family currently covers commodities, currencies and emerging markets (India). The notes are senior, unsecured, unsubordinated debt securities issued by Barclays Bank PLC, and their returns are linked to the performance of their underlying benchmarks. You buy the ETN, and Barclays promises to pay you the amount reflected in the index, minus fees.

The big calling card for ETNs is tax efficiency. BGI believes that, under current tax law, ETNs should be treated as "prepaid contracts." If that’s the case, the funds will never pay distributions, and shareholders will only owe taxes when they sell the fund. If you hold for more than a year, all the gains will be long-term gains, taxed at 15%.

In contrast, closed-end funds and other buy-write strategies generate income … lots of it. As mentioned, most strategies are now yielding 9-10% per year. This income gets paid out, and shareholders must pay taxes on it. The difference between paying taxes now and deferring them into the future can add up.

There are a number of people, however, who believe that Barclays' tax treatment of the ETNs is too aggressive, and that it is unlikely that they will qualify for such favorable treatment. If that happens, shareholders could be exposed to back taxes on gains.

The other downside of the ETNs, of course, is that they are debt. If Barclays were to go bankrupt, ETN-holders would be essentially out of luck. That's unlikely, but stranger things have happened (if rarely).

BWV carries an annual fee of 0.75%, significantly higher than the expense ratio of most ETFs (particularly BGI’s iShares), but is significantly cheaper than comparable buywrite closed-end funds, which generally have not only higher expense ratios, but also significant underwriting fees.