2016 Mid-Year Update On UBS's ETRACS 2x Leveraged ETNs

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Includes: BDCL, BDCS, CEFL, DVHI, DVHL, DVYL, FMLP, HDLV, HOML, HOMX, IMLP, LBDC, LMLP, LRET, MLPI, MLPQ, MLPZ, MORL, MORT, MRRL, RWX, RWXL, SDYL, SMHD, SPLX, UBS
by: Stanford Chemist

Summary

UBS offers a diverse range of 2x leveraged ETNs covering equity, debt and alternative investment classes.

Two funds have been replaced, and Series B ETNs have been launched.

Relevant data for all of the funds are updated.

Introduction

UBS (NYSE:UBS) is the sponsor of the ETRACS range of exchange-traded notes [ETNs]. These ETNs cover a broad range of investment classes, including traditional equity as well as alternative investment types such as real estate investment trusts [REITs], mortgage REITs [mREITs], master limited partnerships [MLPs], business development companies [BDCs] and closed-end funds [CEFs]. A number of the ETRACS ETNs are 2x leveraged, which means that they seek to return twice the total return of the underlying index, minus fees. This allows the 2x ETNs to offer sometimes alluringly high headline yields, making them attractive for income investors. Additionally, the funds reset their leverage reset monthly rather than daily, which could lead to reduced leverage decay.

I first provided an overview of the ETRACS 2x leveraged ETNs in Mar. 2015, which was followed by an update in Aug. 2015. The current article is intended to provide a 2016 mid-year update to this suite of 2x ETNs, to allow investors to see "at a glance" the yields and total expense ratios of the funds, as well as provide an overview of the events that have transpired since my last update article.

The funds

The following table shows the fund name, ticker symbol, inception date, 3-month average volume, and the corresponding 1x leveraged fund (where available). Volume data are from Morningstar. A brief explanation on the classification: all broad equity, dividend equity, small-cap equity and homebuilder equity ETNs are grouped under "Equity". The "Alternative Equity" class includes MLP, REIT, mREIT, and BDC funds. "Balanced" includes CEF and multi-asset funds.

Fund Ticker Inception Volume 1x fund
Equity
Monthly Reset 2xLeveraged S&P 500 Total Return ETN (NYSEARCA:SPLX) 3/2014 12K (NYSEARCA:SPY)
Monthly Pay 2xLeveraged S&P Dividend ETN (NYSEARCA:SDYL) 5/2012 5K (NYSEARCA:SDY)
Monthly Pay 2xLeveraged Dow Jones Select Dividend Index ETN (NYSEARCA:DVYL) 5/2012 8K (NYSEARCA:DVY)
Monthly Pay 2xLeveraged US High Dividend Low Volatility ETN (NYSEARCA:HDLV) 9/2014 18K
Monthly Pay 2xLeveraged US Small Cap High Dividend ETN (NYSEARCA:SMHD) 3/2015 42K
Monthly Reset 2xLeveraged ISE Exclusively Homebuilders ETN (NYSEARCA:HOML) 3/2015 35K (NYSEARCA:HOMX)
Alternative equity
Monthly Pay 2xLeveraged Wells Fargo MLP Ex-Energy ETN (NYSEARCA:LMLP) 6/2014 59K (NYSEARCA:FMLP)
Monthly Pay 2xLeveraged MSCI US REIT Index ETN (NYSEARCA:LRET) 5/2015 25K (NYSEARCA:VNQ)
Monthly Pay 2xLeveraged Mortgage REIT ETN (NYSEARCA:MORL) 10/2012 254K (NYSEARCA:MORT)
Monthly Pay 2xLeveraged Dow Jones International Real Estate ETN (NYSEARCA:RWXL) 3/2012 7K (NYSEARCA:RWX)
2xMonthly Leveraged Alerian MLP Infrastructure Index ETN Series B (NYSEARCA:MLPQ) 7/2010 13K (NYSEARCA:MLPI), (NYSEARCA:AMLP)
2xMonthly Leveraged S&P MLP Index ETN Series B (NYSEARCA:MLPZ) 2/2016 17K (NYSEARCA:IMLP)
2xLeveraged Long Wells Fargo Business Development Company Index ETN (NYSEARCA:BDCL) 5/2011 221K (NYSEARCA:BDCS)
Balanced
Monthly Pay 2xLeveraged Closed-End Fund ETN (NYSEARCA:CEFL) 12/2013 158K (NYSEARCA:YYY)
Monthly Pay 2xLeveraged Diversified High Income ETN (NYSEARCA:DVHL) 11/2013 20K (NYSEARCA:DVHI)
Click to enlarge

The following table shows the yields, total expense ratios [TERs], and adjusted TERs (see below) of the funds, listed in alphabetical order. The TERs were obtained from the funds' pricing supplements and the yield represents the 12-month annualized yield based on the three most recent distributions. MLPQ and MLPZ, being recently launched, have only paid out one distribution each, and I do not believe that the annualized yield calculated by UBS is indicative of the future yield that will be offered by the two funds.

Ticker TER* Yield Adjusted TER
BDCL 0.85% 17.02% 0.74%
CEFL 0.90% 18.63% 0.77%
DVHL 1.25% 11.59% 0.94%
DVYL 0.75% 6.65% 0.69%
HDLV 1.45% 9.71% 1.04%
HOML 1.65% 0.00% 1.14%
LMLP 1.45% 14.34% 1.04%
LRET 1.65% 6.87% 1.14%
MLPQ 1.65% 0.65% 1.14%
MLPZ 1.95% 0.52% 1.29%
MORL 0.80% 20.28% 0.72%
RWXL 1.00% 7.52% 0.82%
SDYL 0.70% 5.13% 0.67%
SMHD 1.65% 13.72% 1.14%
SPLX 1.25% 0.00% 0.94%
Click to enlarge

*Does not include 3-month LIBOR, which currently stands at 0.63%.

The yields and TERs of the funds are also displayed graphically below, arranged in order of smallest to largest. Note that SPLX and MPLX are total return funds, and hence pay zero distributions. MORL currently pays the highest yield of 20.28%, followed by CEFL at 18.63%. All of the ETNs pay monthly except for BDCL, MLPQ and MLPZ.

Regarding the TERs, UBS engages in the (rather dubious, in my opinion) practice of hiding their financing spread within their pricing supplement, which makes their headline management fee (known as "tracking rate") look lower. For example, SDYL has an annual tracking rate of 0.30%, a figure that is displayed prominently on the fund's website, but you have to dig into the pricing supplement to see that you are being charged an additional 0.40% in financing spread, which means that the total financing rate will be 0.40% + 3-month LIBOR (currently 0.63%). Adding all three fees together gives a total expense ratio of 0.30% (tracking rate) + 0.40% (financing spread) + 0.63% (3-month LIBOR) = 1.33%.

However, remember that these ETNs are 2x leveraged. Thus, I devised an "adjusted TER" that takes into account both the current LIBOR of 0.63%, and the leverage of the fund, which can be achieved by simply adding 0.63% to the TER and then dividing the result by 2. I believe that this value is more useful when one is trying to compare the expense ratio of the 2x ETNs versus unleveraged funds. In fact, with some of the adjusted TERs being lower than the expense ratios for unleveraged 1x funds, it might be able to juice your portfolio by up to nearly 1% a year by synthetically replicating a 1x position (as described in "Build Your Own Leveraged ETF (ETRACS Edition)").

MLPL reborn

Since my last update article, two of the 2x leveraged MLP ETNs have been shuttered, namely 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). As explained in "Explaining The Action In MLPL", the two funds closed because the underlying index dropped by more than 30% from its most recent month close value as a result of catastrophe in the oil markets.

Luckily, leverage junkies didn't have to wait long for their leverage fix. Just over a week later, MLPL and MLPV were resurrected as MLPQ and MLPZ, respectively. Investors brave enough to buy into the two new funds at inception have been rewarded with +30% gains over the past three months.

MLPQ Total Return Price Chart

As detailed in "MLPL Reborn?", there are some notable differences between MLPQ/MLPZ and their deceased brethren, such as increased fees and more importantly, a change in the mandatory acceleration (redemption) criteria and the introduction of a new "loss rebalancing event", which should help prevent closure of the funds should similar circumstances as before occur again. Interested readers are encouraged to consult my linked article above.

Series B ETNs

Additionally, in October of last year, UBS launched six new Series B ETNs, two of which are 2x leveraged. These are:

  • ETRACS Monthly Pay 2xLeveraged Mortgage REIT ETN Series B (NYSEARCA:MRRL)
  • ETRACS 2xLeveraged Long Wells Fargo Business Development Company Index ETN Series B (NYSEMKT:LBDC)

MRRL is essentially the same to MORL, and LBDC to BDCL, which is why these were not presented in the table and graphs above. The performance of two series of ETNs since the inception of the Series B notes is nearly identical. The respective funds also have the same fee structures.

MORL Total Return Price Chart

MORL Total Return Price data by YCharts

The only difference is in the identity of the guarantor of the notes. Recall that ETNs are unsecured debt instruments, meaning that should UBS fail, the notes could be rendered worthless. This is a risk than all ETN investors have to shoulder compared investing in ETFs. Essentially, the original "Series A" ETNs are co-guaranteed by both UBS AG and UBS Switzerland AG, whereas the newer "Series B" ETNs are guaranteed by UBS AG only. From the press release (Oct. 08, 2015) (emphasis added):

In connection with the previously announced transfer by UBS AG to UBS Switzerland AG of specified assets, UBS Switzerland AG became a co-obligor of all outstanding debt securities designated as Series A, including the Series A ETRACS ETNs, issued by UBS AG prior to the transfer date. Any UBS ETRACS ETNs issued after the transfer date have been or will be designated as Series B, including the six new products launched today, and do not have the benefit of the co-obligation.

In theory, this would make the Series B ETNs less valuable than the Series A, since the former are solely guaranteed by UBS AG. However, it is hard to imagine a scenario where UBS AG goes under and its subsidiary, UBS Switzerland AG (and by extension the Series A notes) remains unscathed. It is also unclear why only two of the original 2x leveraged ETNs have Series B counterparts, and not the others.

(Addendum: MLPQ and MLPZ, being launched after the transfer date, are also designated as Series B. However, while MLPZ has the same fee structure as the defunct MLPV, MLPQ's expense ratio is more than 1% greater than that of MLPL which it replaced.)

Conclusion

The ETRACS 2x leveraged ETNs allow investors to obtain leveraged participation in traditional equity as well as alternative equity classes such as REITs, mREITs, BDCs, MLPs and CEFs. For the average investor, this leverage can be obtained much more cheaply compared to a margin loan from a broker.

This article provides an update to the ETRACS line-up of 2x leveraged ETNs. It also describes the replacement of two MLP funds, as well as the introduction of the Series B ETNs.

As this is my 100th article, I would like to thank all of my Seeking Alpha followers and readers who have accompanied me on my investing journey and given me much insight and food for thought. If you are interested in receiving notifications about my future articles, please don't hesitate to click the "follow" button next to my name!

Disclosure: I am/we are long CEFL, MLPQ, HDLV, BDCL.

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.