CEFL - Meet The New Index, Same As The Old Index

| About: UBS ETRACS (CEFL)

Summary

The Index of 30 closed-funds in reconstituted and rebalanced on an annual basis, at the beginning of each year.

Last year the rebalancing had a significant impact on CEFL in terms of the dividend.

The actual rebalancing has had very little impact. Thus, fears that it would were overblown.

The UBS ETRACS Monthly Pay 2xLeveraged Closed-End Fund ETN (NYSEARCA:CEFL) and the YieldShares High Income ETF (NYSEARCA:YYY) are based on the ISE High Income™ Index an index of 30 closed-ends maintained by International Securities Exchange, LLC, the index sponsor.

As the CEFL pricing supplement states:

The composition of the index is reviewed and the Index is reconstituted and rebalanced on an annual basis by the Index Sponsor. During the review, the procedures described under "--Index Construction" will be followed to select and weight the components of the Index, which may result in new component being selected and existing components being dropped. The Index employs a rolling rebalance schedule whereby one third of the component changes are implemented at the close of trading on each of the first, second and third trading days in January of the following year and each change becomes effective at the opening on the second, third and fourth trading day of the new year, respectively.

There was considerable concern regarding the possible effect the year-end 2015 CEFL index rebalancing. CEFL underwent a significant rebalancing at the end of 2014. The bad news was that the dividends were somewhat lower. However, as a result of the rebalancing CEFL was then trading at a deeper discount to the net asset value of the closed-end funds that comprise the index. Both the lower dividend and the greater discount to net asset value of the closed-end funds that comprise the index were due largely to the elimination of the PIMCO High Income Fund (NYSE:PHK). As I pointed out in 18% Yielding CEFL Trading At A Discount To Effective Intrinsic Value, PHK was trading at a whopping 53.9% premium. PHK, because of its enormous premium, contributed or rather detracted 2.35% to the weighted average discount of 4.37%. This means that without PHK, weighted average discount for the 30 closed-end funds would have been 6.72%. at that time. PHK does pay a hefty double-digit dividend yield and its elimination reduced the CEFL dividend.

In Seeking Alpha articles such as "Are You Ready For CEFL's Year-End Rebalancing?", and "Has The CEFL Rebalancing Train Left The Station?" Seeking Alpha contributor Stanford Chemist warned of the consequences of the annual rebalancing including the possibility that front-running of the rebalancing could adversely impact CEFL and YYY holders. Some of the comments to Seeking Alpha in my article "CEFL Dividend Stable, Yield At 23.8% On Lower Price" contained somewhat alarming statements such as "beware of the rebalancing," "the MAJORITY of the CEFL components were replaced last year" and "the "rebalancing" is a huge factor that he fails to comment on, I sold all but 1 share and will buy back in when it is settled next year."

The table below shows all 30 of the CEFL components as of January 8, 2016. The first column of the table indicates whether the component is old or new. The old components are those that were listed in my article "CEFL Dividend Stable, Yield At 23.8% On Lower Price" which had a table of CEFL components as of December 18, 2015. Since January 8, 2016 was the fourth trading day of the new year, all of the changes due to the rebalancing and reconstitution of the index should be reflected in January 8, 2016 table.

As can be seen from the table, only three of the components comprising just 9.3% of the index are new additions that were not included in the December 18, 2015 table. These three are PIMCO Corporate & Income Opportunity Fund (NYSE:PTY) with a weight of 3.66% in the index, Royce Value Trust (NYSE:RVT) with a weight of 4.07% in the index and Alliancebernstein Global High Income Fund Inc (NYSE:AWF) with a weight of 1.57% in the index.

PTY is trading at a premium to net asset value of 2.5% and thus will slightly decrease the overall discount to net asset value of the index. PTY pays an 11.8% dividend which will not significantly change the dividend paid by CEFL. RVT pays an 13.8% dividend which will add to the dividend paid by CEFL. RVT is trading at a discount to net asset value of 14%. That is more than the weighted average of the other components and thus will slightly increase the overall discount to net asset value of the index

AWF is trading at a discount to net asset value of 10.5%. That is less than the weighted overall discount to net asset value of the index and thus will slightly decrease the overall discount to net asset value of the index. AWF pays an 8.8% dividend which will decrease the dividend paid by CEFL. Thus, on balance the three new additions to the index will have very little impact on either the dividend or the discount to net asset value of CEFL.

My constructive view on CEFL stems not only from the wide discount to book value of the closed-end funds, but also from the very large dividends paid by CEFL. One troubling aspect of CEFL is the significant amount of the dividends paid by the closed-end funds that comprise CEFL that consists of return of capital. My calculation using available data indicates that 25.1% of the January 2016 CEFL dividend will consist of return of capital. However, there does not seem to be any statistically significant relationship between return of capital and the discounts to book value that the individual closed-end funds trade at.

CEFL Components as of January 8, 2016

Old or New

Name

Ticker

Weight

old

GAMCO Global Gold Natural Resources & Income Trust

GGN

4.35

old

Doubleline Income Solutions

DSL

4.33

old

Prudential Global Short Duration High Yield Fund

GHY

4.33

old

Eaton Vance Limited Duration Income Fund

EVV

4.31

old

PIMCO Dynamic Credit Income Fund

PCI

4.29

old

Western Asset Emerging Markets Debt Fund

ESD

4.27

old

Eaton Vance Tax-Managed Global Diversified Equity Income Fund

EXG

4.23

old

Aberdeen Aisa-Pacific Income Fund

FAX

4.22

old

Morgan Stanley Emerging Markets Domestic Debt Fund

EDD

4.22

old

Calamos Global Dynamic Income Fund

CHW

4.19

old

Alpine Global Premier Properties Fund

AWP

4.19

old

ING Global Equity Dividend & Premium Opportunity Fund

IGD

4.15

old

Allianzgi Convertible & Income Fund

NCV

4.11

old

Alpine Total Dynamic Dividend

AOD

4.1

new

Royce Value Trust

RVT

4.07

old

Clough Global Opportunities Fund

GLO

3.94

new

PIMCO Corporate & Income Opportunity Fund

PTY

3.66

old

Western Asset High Income Fund II

HIX

3.51

old

Wells Fargo Advantage Income Opportunities Fund

EAD

3.3

old

Prudential Short Duration High Yield Fd

ISD

3.15

old

Backstone /GSO Strategic Credit Fund

BGB

2.9

old

Wells Fargo Advantage Multi Sector Income Fund

ERC

2.64

old

BlackRock International Growth and Income Trust

BGY

2.45

old

Blackrock Corporate High Yield Fund

HYT

2.26

old

Blackrock Multi-Sector Income

BIT

2.02

old

First Trust Intermediate Duration Prf.& Income Fd

FPF

1.81

new

Alliancebernstein Global High Income Fund Inc

AWF

1.57

old

Eaton Vance Tax-Managed Diversified Equity Income Fund

ETY

1.35

old

Invesco Dynamic Credit Opportunities Fund

VTA

1.14

old

Nuveen Preferred Income Opportunities Fund

JPC

0.95

Click to enlarge

Disclosure: I am/we are long CEFL.

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.