After a catastrophic month for the oil markets, UBS (NYSE:UBS) is shutting two of its ETNs: the ETRACS 2x Monthly Leveraged Long Alerian MLP Infrastructure ETN (NYSEARCA:MLPL) and the ETRACS 2x Monthly Leveraged S&P MLP Index ETN (NYSEARCA:MLPV). The closure of MLPL is ironic given that it was the first of UBS' 2x leveraged ETNs to be launched, with an inception date of Jul. 2010.
The closure of MLPL makes me sad on a number of levels. The foremost reason is of course the horrific price loss suffered by unitholders over the past month. The second is the realization that monthly resetting can have a highly deleterious impact on unit price when the underlying is in a free-fall (as examined below).
The third is the nostalgia associated with the fact that as the first 2x leveraged ETN to be released, MLPL had an relatively low expense ratio of 0.85% (excluding 3-month LIBOR which currently stands at 0.62%), which makes its expense ratio comparable to industry giants Alerian MLP ETF (NYSEARCA:AMLP) and JPMorgan Alerian MLP ETF (NYSEARCA:AMJ), both at 0.85%, once the 2x leverage of MLPL is taken into account. Since then, of course, UBS has continually increased the expense ratio of its new 2x ETN funds, with the only-recently released MLPV (Jul. 2015) having a tracking fee of 0.95% plus a buried-in-fine-print financing rate of 1%, giving a total expense ratio of 1.95% (excluding LIBOR), as detailed in my recent article "An Update On UBS's ETRACS 2X Leveraged ETNs".
With a total return profile that closely matches that of MLPL, I have no idea why anyone would pay an additional 1.15% in expense ratio for MLPV when you get essentially the same result. Perhaps the closure of MLPV, only six months after it was launched, is some kind of cosmic karma for UBS' increasingly money-grubbing ways.
Trigger for the closure
According to the press release released on Jan. 20th:
UBS Investment Bank today announced that all outstanding notes of [MLPL] will be mandatorily redeemed in accordance with the terms of the Securities as a result of the occurrence of an Acceleration Event, triggered as a result of the intraday index value decreasing by more than 30% from the most recent Monthly Initial Closing Level (as defined in the prospectus supplement relating to the Securities) to below 349.81 on January 20, 2016 (the "Acceleration Date").
Essentially, the trigger for the closure is the index value falling by more than 30% of its most recent month close value. This trigger can be activated intraday, and thus even if by market close the index manages to recover to above this 30% threshold, the acceleration still happens.
In fact, this is exactly what transpired on Jan. 20th, at least upon examination of the price action of the ETRACS Alerian MLP Infrastructure Index ETN (NYSEARCA:MLPI), an ETN that tracks the same index as MLPL, but is unleveraged. The reason I couldn't use the actual index for this calculation was because, at the time of writing, the Alerian website only provided index values [AMZI] up to Jan. 15th.
On Dec. 31st, 2015, MLPI closed at $25.62. On Jan. 20th, 2016, MLPI closed at $18.37, a decline of 28.3%. However, the intraday low reached was $17.64, a decline of 31.1% from the previous monthly close, and sufficient to trigger the mandatory redeeming event.
An ugly day for MLPL
In a Seeking Alpha news release reporting the closure of the ETNs, a number of readers were upset or baffled with the ugly performance of MLPL vis-a-vis the corresponding 1x fund on that fateful day. For example, vassk writes:
MLPL was down over 30% when AMLP, the fund it follows 2x, was down 7%. The whole purpose of UBS was being able to regulate. Hope there's a class action....I'm sure there will be.
Because AMLP is an ETF, and is thus burdened by deferred tax expenses that can help or hinder its performance depending on the circumstance, a more apt comparison might be with MLPI, a 1x ETN that tracks the same index as MLPL.
On Jan. 20th, MLPL closed at $9.22 (indicative value on UBS website)*, down -19.19% for the day, while MLPI closed at $18.37, down -6.85%. At the lows, MLPL was down by -32.60% while MLPI was down by "only" -10.55%.
(*MLPL appeared to be halted for some time during Jan. 20th. Additionally, Yahoo Finance gives the close value for MLPL as $8.74 rather than $9.22. This discrepancy could be due to there being no trades for MLPL near the end of the day or just panic selling by MLPL investors below the indicative NAV of the fund).
What's going on? Comparison of both closing and daily low values of the two funds indicates that MLPL has performed much worse than would be expected for a 2x fund, in fact its performance resembled more like a 3x fund!
The answer to this discrepancy lies in the monthly reset feature of MLPL. Remember that the total return of MLPL is linked to twice the monthly return performance of the underlying index. As noted previously, MLPI's close of $18.37 on Jan. 20th represented a 28.3% decline from its monthly closing value of $25.62. Meanwhile, MLPL's monthly closing value was $21.11. In order for MLPL to match twice the monthly return of MLPI at the close of Jan. 20th, its value must decline by a total of 28.3% x 2 = 56.6% from the previous month, or to $9.16, at the of the day. Indeed, MLPL closed at $9.22 on Jan. 20th, which is within 1% of the above calculated value. Unfortunately, having to drop to $9.22 from the previous day's close of $11.41 represented an ugly -19.19% decline for the day, much more than twice that of MLPI's (-6.85%).
The price action of both funds since Dec. 31st, 2015 confirms that MLPL has tracked approximately twice the total return of MLPI.
For a comparative performance of the ETRACS 2x leveraged monthly-resetting ETNs vs. their hypothetical daily-resetting counterparts, see "Has Monthly Resetting Helped Or Hurt The ETRACS 2x Leveraged ETNs?".
What will MLPL unitholders get?
As noted in the press releases, MLPL holders will receive the "Acceleration Amount" on the Acceleration Settlement Date, which will be Feb. 1st, 2016. In the prospectus, the "Acceleration Amount" is explained as:
The "Acceleration Amount" will equal [A] the product of [i] the Current Principal Amount and [ii] the Index Factor as of the last Index Business Day in the Acceleration Valuation Period plus [B] the Coupon Amount with respect to the Coupon Valuation Date immediately preceding the Acceleration Date if on the last Index Business Day in the Acceleration Valuation Period the Coupon Ex-Date with respect to such Coupon Amount has not yet occurred, plus [C] the Adjusted Coupon Amount, if any, minus [D] the Accrued Tracking Fee as of the last Index Business Day in the Acceleration Valuation Period, minus [E] the Accrued Financing Charges as of the last Index Business Day in the Acceleration Valuation Period plus [F] the Stub Reference Distribution Amount as of the last Index Business Day in the Acceleration Valuation Period, if any.
From what I understand from the above, this just means that UBS will pay basically what is the indicative value of MLPL at the last day of the "Acceleration Valuation Period", including any distributions that are due to the unitholders.* This suggests that there are no significant arbitrage opportunities to buying or selling MLPL before the valuation date, unless the ETN is found to be, for whatever reason, trading significantly above or below its NAV at any one time. While the prospectus does state that there is a 0.125% fee for redemption of the notes, this does not appear to apply to the acceleration event because this fee is not listed in the above calculation. The above analysis probably applies to MLPV, as well.
Note however that if MLPL continues to decline closer towards the acceleration date, MLPL holders will receive less in exchange for their notes when the time comes to redeem them. In fact, it is possible for the notes to be worth $0 at that time. This point should be obvious but I thought I should still make it anyway.
(*Disclaimer: It is entirely possible that my interpretation of the prospectus regarding what MLPL unitholders will receive is wrong. Please do your own due diligence on this. If anyone has any other insight into how the Acceleration Amount is calculated, please share with us in the comments section below.)
With the closure of MLPL and MLPV, to my knowledge, there does not appear to be any more 2x leveraged MLP funds remaining on the market. Former MLPL and MLPV unitholders who still wish to obtain leveraged exposure to the MLP space (brave people that you are) may consider obtaining margin from their broker for an investment into a regular 1x MLP fund such as AMLP or AMJ. Alternatively, MLP CEFs, many of which are leveraged could also be considered. My favorites in the CEF space are the Kayne Anderson MLP Investment Company (NYSE:KYN) and the Tortoise Energy Infrastructure Corp. (NYSE:TYG) (see "Benchmarking The Performance Of MLP CEFs: Is Active Management Worth It?" for my take on several MLP CEFs).
Are any other ETRACS 2x ETNs in danger of acceleration? The unleveraged ETRACS Wells Fargo MLP Ex-Energy ETN (NYSEARCA:FMLP) has declined by 15% in January, so a further 15% drop within this month will trigger the acceleration of the 2x leveraged ETRACS Monthly Pay 2xLeveraged Wells Fargo MLP Ex-Energy ETN (NYSEARCA:LMLP). Coincidentally, a 60% decline in LMLP (30% x 2) from its previous monthly close of $12.69 will bring its indicative value down to $5.08, just above the $5.00 threshold below which units will also be mandatorily redeemed. At the time of writing, LMLP's market price was $8.97.
ETRACS Monthly Pay 2xLeveraged Mortgage REIT ETN (NYSEARCA:MORL) and the ETRACS 2xLeveraged Long Wells Fargo Business Development Company Index ETN (NYSEARCA:BDCL) appear to be in slightly less danger than LMLP, as their underlying 1x funds, the Market Vectors Mortgage REIT Income ETF (NYSEARCA:MORT) and the ETRACS Wells Fargo Business Development Company Index ETN (NYSEARCA:BDCS), have declined by only 13% and 14% this month, respectively. Additionally, the higher unit prices of MORL (currently $9.36) and BDCL (currently $12.12) should offer some protection against the $5.00 acceleration floor.
A final note about leverage: it you aren't comfortable with leverage, then you shouldn't have been investing in MLPL in the first place. MLPL is not an inherently flawed product, I believe, as it behaved exactly as it should, and UBS should not be unfairly criticized for launching this product (I do, however, lambast the egregious fees for MLPV). In fact, $10,000 invested into the 2x leveraged MLPL one year ago would have done better than a $20,000 investment in the 1x leveraged MLPI from a dollar viewpoint, even though both strategies would have had the same exposure to underlying index on day 1. The first investment into MLPL would be worth $2,190 today, good for a $7,810 loss, while the second investment into MLPI would be worth $10,480, representing a $9,520 loss. This indicates that it would have been relatively better for an investor to purchase MLPL directly rather than investing twice the amount in the unleveraged MLPI. This issue is explored further in my article "The Real Danger Of Leveraged ETFs And ETNs".
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.