Members of the Cambridge Income Laboratory had an early look at this article.
The third day of the rebalancing of the ISE High Income Index (YLDA), tracked by both the ETRACS Monthly Pay 2X Leveraged Closed-End Fund ETN (NYSEARCA:CEFL) and the YieldShares High Income ETF (NYSEARCA:YYY), has come and gone. For background information about the rebalancing event, see "Are You Ready For CEFL/YYY's 2016-End Rebalancing?" and the links within.
As the changes made to the index were hidden from the public beforehand, there was a lot of uncertainty about which CEFs were going to be added to the index, and which were to be removed. Based on volume and price action that was witnessed at the end of the first day of rebalancing, I curated a preliminary list of CEFs that was used to generated a small profit on the second day (see "CEFL Rebalancing: What We Know So Far"). However, the third day was a big dud in terms of trading potential. This could have been due to the fact that during the middle of the third day of trading, YieldShares published an updated list of holdings that revealed the composition of YYY after the first day of rebalancing. The full list of 30 CEFs in 2017's index together with their allocated weights could be quickly determined after that, and with trades becoming too crowded, the liquidity premium was lost.
I know that I'm not the only one that has been displeased with the silence from ISE. At the time of writing, ISE's site for YLDA still states simply that "Index data not available". Reader stevejar commented:
Right, I say the lack of information is outrageous. NASDAQ bought ISE last year--and now sells the rebalancing information to large investors (rather than post the information on-line for free for all investors). Some of my closed-end funds (like AWP) were really battered--presumably from selling by traders with information I do not have.
I'm not sure whether YYY was forced by pre-existing conditions to publish its daily holdings (apparently only "active" ETFs are required to do so), but they sure delayed it as long as they can, or at least until the effects of having the holdings data were dampened. Of course, CEFL, being technically a note, is under no legal obligation to release any holdings data at all.
I'm sure that with the rebalancing complete, the full list of holdings will be released by ISE soon, but for those who are too impatient to wait, here are the list of the 30 CEFs in YLDA, and hence also the funds YYY and CEFL. Note that this is still technically a predicted list, as calculated from the YieldShares site that at writing presented the holdings of YYY after the first day of rebalancing.
|Cohen & Steers Quality Income Realty Fund||(NYSE:RQI)||4.49%||7.57%||m||-7.13%|
|Alpine Total Dynamic Dividend Fund||(NYSE:AOD)||4.30%||8.91%||m||-15.56%|
|BlackRock Corporate High Yield Fund||(NYSE:HYT)||4.29%||7.63%||m||-7.94%|
|Eaton Vance Tax-Advantaged Global Dividend Income Fund||(NYSE:ETG)||4.28%||8.48%||m||-10.32%|
|Calamos Strategic Total Return Fund||(NASDAQ:CSQ)||4.25%||9.33%||m||-8.47%|
|Calamos Convertible Opportunities and Income Fund||(NASDAQ:CHI)||4.21%||10.89%||m||-2.95%|
|Liberty All-Star Equity Fund||(NYSE:USA)||4.21%||9.04%||q||-14.86%|
|Wells Fargo Income Opportunities Fund||(NYSEMKT:EAD)||4.17%||9.66%||m||-8.23%|
|BlackRock Multi-Sector Income Trust||(NYSE:BIT)||4.15%||8.36%||m||-9.16%|
|BlackRock Credit Allocation Income Trust||(NYSE:BTZ)||4.13%||6.44%||m||-8.97%|
|PIMCO Dynamic Credit and Mortgage Fund||(NYSE:PCI)||4.10%||9.63%||m||-4.31%|
|Morgan Stanley Emerging Markets Domestic Debt Fund||(NYSE:EDD)||4.09%||9.90%||q||-11.69%|
|Prudential Global Short Duration High Yield Fund||(NYSE:GHY)||4.05%||8.05%||m||-10.21%|
|DoubleLine Income Solutions Fund||(NYSE:DSL)||4.00%||9.45%||m||-8.92%|
|Blackstone/GSO Strategic Credit Fund||(NYSE:BGB)||3.97%||8.20%||m||-8.96%|
|First Trust Intermediate Duration Preferred & Income Fund||(NYSE:FPF)||3.89%||8.53%||m||-2.83%|
|John Hancock Tax Advantaged Dividend Income Fund||(NYSE:HTD)||3.48%||6.94%||m||-4.34%|
|Eaton Vance Limited Duration Income Fund||(NYSEMKT:EVV)||3.21%||7.62%||m||-9.81%|
|Wells Fargo Multi-Sector Income Fund||(NYSEMKT:ERC)||3.20%||8.57%||m||-9.26%|
|Western Asset High Income Fund II||(NYSE:HIX)||2.89%||9.13%||m||-7.28%|
|AllianceBernstein Global High Income Fund||(NYSE:AWF)||2.88%||7.62%||m||-6.11%|
|Templeton Emerging Markets Income Fund||(NYSE:TEI)||2.66%||7.18%||q||-9.05%|
|Prudential Short Duration High Yield Fund||(NYSE:ISD)||2.32%||7.91%||m||-7.56%|
|Western Asset High Income Fund||(NYSE:HIO)||2.24%||7.16%||m||-8.39%|
|Nuveen Quality Preferred Income||(NYSE:JPS)||2.03%||7.98%||m||-2.09%|
|First Trust High Income Long/Short Fund||(NYSE:FSD)||1.79%||7.27%||m||-7.77%|
|Nuveen Preferred Income Opportunities Fund||(NYSE:JPC)||1.61%||7.80%||m||-4.47%|
|Nuveen Credit Strategies Income Fund||(NYSE:JQC)||1.34%||7.17%||m||-6.86%|
|AllianzGI Convertible & Income Fund||(NYSE:NCV)||1.00%||12.02%||m||-5.69%|
|Blackrock Debt Strategies Fund||(NYSE:DSU)||0.91%||6.60%||m||-8.93%|
Three funds, USA, EDD and TEI pay quarterly, while the rest pay monthly. The data is also shown graphically.
Predicted yield and discount
Based on the above data, the weighted-average yield of the index is 8.30%. This is a full 12% lower than the yield of the old index, 9.43%, last week. Note that both yield figures do not include special distributions. CEFL would therefore be expected to yield twice the index yield, or 16.59%, excluding special distributions.
Assuming that the stock price of CEFL stays the same, I would expect the CEFL to pay out about $0.205 for its February coupon (don't worry Prof. Lance Brofman, I'm only doing this once!). This is actually only slightly less than the $0.211 distribution paid out in February of last year, but don't thank the new index for that. Rather, the distributions in the early months of 2016 were systematically depressed by the falling share price of CEFL, a phenomenon that has also been previously explained by the good professor. We can verify this if we compare the coupon in February 2016 ($0.211) to the amount three months later in May 2016 ($0.271), when the price of CEFL had mostly recovered - the distribution was 28% higher in May even though the index constituents were the same.
ISE also appears to have selected funds with narrower discounts. The new index has a weighted-average discount of -8.10%, compared to -10.00% for the old index.
What do you think?
There's no escaping the fact that the new index is yielding significantly less than the old index, by some 12% as I estimate. The 20%+ yields of CEFL could be a thing of the past, at least for the coming year (or unless the share price of CEFL tanks). Why has this happened? Well, it seems that ISE had heard all of the complaints about the declining share price of CEFL and how the ETN was nothing more than a glorified return-of-capital (ROC) instrument.
So this year, ISE's highly discretionary action was to exclude the most highly-yielding CEFs from the index. For instance, the 10%+ yielding EXG (NYSE:EXG) (12.10%), GGN (NYSEMKT:GGN) (11.56%), IGD (NYSE:IGD) (10.63%), ETJ (NYSE:ETJ) (12.25%), KYN (NYSE:KYN) (11.13%), ETW (NYSE:ETW) (11.45%) and PHK (NYSE:PHK) (13.55%) all were ranked in the top 20 of funds for inclusion as I calculated using the methodology that ISE themselves provided, but these were eschewed in favor of CEFs such as the 7.31%-yielding HTD that was ranked ... 71st? What? Steps to exclude highly-discounted CEFs, which might represent value traps, were possibly taken in a similar vein.
Reader jerbear offered this comment:
If they are ignoring the defined methodology of the index and using their own discretion then it has become an actively managed fund.
The whole point of investing in ETFs and ETNs is to use a defined methodology and avoid the human factor that historically results in poor performance. Am I missing something here?
What do you think about the CEFL/YYY index? Like it (potentially better capital preservation going forward) or hate it (imminent distribution cut)? Share your thoughts in the comments section below.
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Disclosure: I am/we are long EXG.
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.