Yes, Virginia, There are High Dividend ETNs

Includes: GCE, JEM, PGD
by: Chance Carson

Exchange-Traded Notes (ETNs) aren’t known for paying high dividends.  In fact, ETNs don’t usually pay dividends at all.  Among the 90 (+) ETNs actively trading today, and flying well below most investor radar screens, there are actually four of these “stealth-like” dividend paying ETNs.  Known by few investment advisors and even fewer investors, dividend paying ETNs have been quietly trading among sophisticated income investors for more than a year.`

The four ETNs which presently pay dividends are Claymore CEF Index Linked Goldman Sachs Connect ETN (NYSEARCA:GCE), BearLinx Alerian MLP Select Index ETN (BSR), Barclays Asian and Gulf Currency Revaluation Note (NYSEARCA:PGD), and Barclays GEMS Index ETN (NYSEARCA:JEM).

GCE invests in a basket of 75 discounted Closed-End Funds following a CEF index selected by Claymore Securities (  GCE’s distribution rate is variable.  The past three quarterly dividends were $1.66, $0.28 and $0.64.

BSR is an energy infrastructure play which invests in fifty Master Limited Partnerships (MLPs) that track the “Alerian MLP Select Index.”  One unique feature of this ETN is its issuance of a 1099 at year-end rather than the K-1 Partnership tax report normally associated with individual MLP holdings.

PGD and JEM are both currency bundles which are pegged, to some extent, to the US dollar. PGD includes currencies of the Saudi Arabian Riyal, Hong Kong dollar, United Arab Emirates Dirham, Singapore dollar and the Chinese yuan.  The JEM bundle includes currency holdings from 15 Global Emerging Markets in Eastern Europe, the Middle East, Africa, Latin America and Asia. 

PGD and JEM both distribute interest earned on the local currency deposits in the form of monthly dividends.  Of these two currency bundles, income-oriented investors have been purchasing JEM for its 7% plus dividend payoutPGD has only a nominal 1% dividend and is more of a currency bet than an income strategy

JEM not only pays a great monthly dividend, but it appears to be exceptionally wellconstructed as a currency bundle. There is substantial geographical diversification within its 15 specific countries selection spread across Asia, Latin America (although Argentina seems somewhat suspect), Eastern Europe, the Middle East and Africa.  The specific currencies in the JEM bundle are the Hungarian Forint, Polish Zloty, Russian Ruble, South African Rand, Turkish Lira, Argentinean Peso, Brazilian Real, Chilean Peso, Columbian Peso, Mexican Peso, Indian Rupee, Indonesian Rupiah, Phillipine Islands Peso, South Korean Won and the Thai Baht.

Given the US dollar’s recent appreciation, currencies not pegged to the dollar will tend to depreciate.  Fortunately for JEM holders, most of its currencies are either tightly, or at least loosely, pegged to the US dollar.  Devaluation of any one or more of JEM’s currencies is perhaps a greater risk.  When defending against potential devaluation, if a country’s central bank holds a large reserve of US dollars (or a growing balance of payments surplus that is building up its dollar reserves), it generally will have the US dollars necessary to bid its currency back up in value.

Ray Hendon, a currency expert in California (see “Carrying the Dollar Upstream”), points out four specific strengths of the 15 countries represented by JEM:

  1. They have a wide geographic diversity.
  2. Nine out of the fifteen countries have an current account surplus as a result of being commodity exporters versus importers.
  3. The macro economic strength of the EM countries is strong in terms of GDP growth and US dollar reserves.
  4. The fifteen countries have a wide spectrum of interest rates ranging from Korea at around 3% to Turkey at 18%.

(For more information on Currency ETFs and Currency ETNs, see Mr. Hendon’s excellent article “Is There a Role for Foreign Currency ETFs in Your Portfolio?”).

Yielding more than 6%, BearLinx Alerian MLP Select ETN (BSR) tracks the performance of the Alerian MLP Select Index and provides investors a wide exposure to energy infrastructure securities via MLPs (Master Limited Partnerships).  Holding 50 different MLP constituents, the Alerian MLP Select Index measures composite performance as calculated by Standard and Poor’s float-adjusted, market capitalization-weighted methodology.

As a brief background, Master Limited Partnerships have traded on the New York Stock Exchange since their creation by the Congressional Act of 1986.  Infrastructure MLPs own and operate long-lived, high-value physical assets that engage in the transportation and storage of natural resources such as refined petroleum products and natural gas.  This emerging asset class represents $140 billion of public market capitalization.  Driven by toll-road business models, significant barriers to entry and attractive organic investment growth, these specialized MLPs have returned an impressive 18% per annum for the past eleven years.

There are three advantages of owning BSR compared to buying single MLPs:

  1. Investors do not receive K-1 Tax Forms, but instead get a Form 1099.
  2. No state tax filings are required.
  3. Investors receive significant diversification across the energy infrastructure and MLP space in a single security.

While BSR trades like an equity on the NYSE, and is similar to investing in an ETF, Exchange-Traded Funds are prohibited from investing more than 25% of their assets in Master Limited Partnerships without paying entity-level income taxes.  Because BSR is not a registered investment company, as an ETN, it provides the same level of liquidity and transparency to investors as a typical ETF, but is a more efficient structure to hold MLPs (an ETN is not subject to the “double taxation” inherent in typical corporate structures investing in MLPs).

As with any asset class, shrewd timing is of the essence.  According to an excellent article in the September 2008 edition of the highly-respected “The 12% Letter” (Stansberry & Associates Investment Research), this is an excellent time to buy energy infrastructure investments.  “The 12% Letter” points out that profits are booming in the pipeline industry, and investor yields currently range from 6% to 8%.  But, despite this, energy infrastructure MLPs are down some 23% from their peak just a month ago.  The article further points out that anytime yield spreads between pipeline MLPs, and Treasury Bonds exceed 3%, it’s time to back up the truck (”The 12% Letter” says yield spreads are now over 4% and the last time this happened back in July 2002, pipelines rallied more than 80% over the ensuing 28 months).  No one knows the potential for BSR, of course, but if the editors of “The 12% Letter” are only partially right, maybe you should consider adding this specialized ETN to your income portfolio.

Perhaps the most intriguing of the income ETNs is the little known Claymore CEF GS Connect ETN (GCE) which tracks the Claymore CEF Index.  The Index is 100% rules-based and tracks the performance of a weighted basket of 75 Closed-End Funds carefully selected for their high liquidity, above average income distributions and deep discounts to Net Asset Value.  The Index follows a modified liquidity weighting methodology developed by Claymore Securities, Inc.  This index portfolio of CEFs is reconstituted and rebalanced every 367 days.

GCE’s current distribution rate is approximately 7.5%, and dividends are paid quarterly.  Most notably, the current discount to NAV of the 75 Closed-End Funds in the Index now exceeds 10%, one of the greatest discounts to Net Asset Value in years.  GCE’s asset class weighting is 35% US Equiity, 30% Global/International Equity, 32% US Fixed Income & Cash and 3% International Fixed Income.

In addition to its excellent yield and historically high discount, GCE’s underlying rules-based selection process is innovative, thorough and exceptionally well-conceived by Claymore.  Claymore first screens all 700+ CEFs to weed out any funds that:

  • Do not trade on US exchanges
  • Generate non-taxable income by investing at least 50% of their assets in non-taxable securities
  • Are interval funds
  • Have less than six months of operating history
  • Have market capitalizations of less than $250 million
  • Have a market share price less than $5.00
  • Have a trading volume of less than 1 million shares in each of the six months preceding reconstitution of the Index
  • Are not organized in the United States of America

After excluding these funds, the remaining CEFs are ranked using a matrix based on discount (90% weighting) and distribution yield (20% weighting).  The top-ranked 75 Closed-End Funds are then included in the Index.  The next rebalancing will occur in March, 2009.

The Index is down about 6% year to date versus the S&P 500 loss of approximately 11%.  The hypothetical annual performance of the Index from March 5, 2002 through June 30, 2008 is 11.23% versus the S&P 500 4.21%.

So…yes, Virginia, there are several high dividend ETNs.  They represent unique alternative asset classes; Currencies, Master Limited Partnerships and Closed-End Funds.  Their dividend distribution rates are excellent, and the timing for each seems attractive.  Check them out, you may be pleasantly surprised by these dividend-paying stealth ETNs.  We were!

Disclosure: none