A Dividend Yield Of 18.6% Could Compensate For Risks With This ETN

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Includes: BDCL, CEFL, MORL, MRRL, SMHD
by: Lance Brofman

Summary

The recent decline in the prices of the 2x Leveraged High Yield ETNs has boosted their yields and could make them attractive for some.

For portfolios that must invest only in securities with very high current yields, CEFL, with an 18.6% dividend yield on an annualized monthly compounded basis, could be a good diversifier.

A special factor involving the largest component of CEFL will reduce the November monthly dividend but will be made up in the December 2018 dividend.

Some of the risks to the financial markets have lessened. However, some have intensified.

The current discount to book value for CEFL is near the highest ever, which makes this a possible buying opportunity.

Outlook For CEFL, Reasons to Buy and Reasons for Caution

The recent market declines have made all of the 2x Leveraged High Yield ETNs more attractive for those seeking to maximize current yield, as their yields are now higher due to their lower prices. Most investors would not consider UBS ETRACS Monthly Pay 2x Leveraged Closed-End Fund ETN (CEFL) a particularly good instrument to hedge against or take advantage of a sharply rising equities market. However, for a portfolio that is constrained to only buy securities with current yields above 15%, CEFL is one of the only games in town.

Much to the dismay of some Seeking Alpha readers, the financial markets seem to be now trading mostly on news involving government policy, particularly that involving the possibilities of destructive trade wars. Many market participants are aware of the risks associated with tariffs and protectionism. Thus, the markets seem to rise and fall with each new development regarding trade policy. It looks like the risk of America pulling out of NAFTA has faded away. Trump essentially did with NAFTA what he did with regard to North Korea's nuclear weapons. Trump simply declared victory and ended the problem. The weapons are still in place. North Korea did not care about American sanctions, rather North Korea needed to have trade relations with China resume, which has happened. Trump has declared that North Korea is now no longer a threat.

The NAFTA agreement was essentially updated and given a new name. The most widely touted "improvement" that Trump supporters mention, is that now for autos and auto parts to be shipped from Mexico to the USA or Canada totally tariff-free, they must be made by workers earning at least $16 per hour. That is true. However, as the Mexican trade minister pointed out, the new agreement stipulates that for autos and auto parts shipped from Mexico to the USA or Canada made by workers earning less than $16 per hour, the maximum tariff that can be imposed shall not exceed the WTO limit of 2.5%.

Canada and Mexico did not insist that the steel and aluminum tariffs that Trump imposed be eliminated as part of the new agreement. However, those countries are parties to the WTO action which will certainly rule that Trump's "national defense" rationale for the steel and aluminum tariffs was preposterous. Thus, the WTO will impose huge financial penalties on the USA. Canada and Mexico are now content to allow those penalties to accumulate.

Even with this NAFTA progress, the risks associated with protectionism still overhang the stock market. China is particularly worrying. The markets have real reasons to be wary. Senator Reed Smoot and Representative Willis C. Hawley probably did many things in their careers, but history only remembers them for the Smoot-Hawley tariff of 1930, which remains today as the prime example of the damage that protectionism can do.

There have been reports that Trump is considering leaving the World Trade Organization. The Trump administration treasury secretary has said that such reports are greatly exaggerated. That is not a complete denial. Leaving the World Trade Organization would make Smoot-Hawley look like a minor setback, in terms of destroying the world economy. In a few years, the World Trade Organization will be imposing enormous fines against the USA for the steel and aluminum tariffs imposed ostensibly for preposterous national security purposes. At that time, if Trump is still in power, the risk of the USA leaving the World Trade Organization and becoming a second-rate economy may be much more serious.

There are some scenarios in which the threat to the markets from protectionism could evaporate overnight. This could result in an equity market melt-up. At any time, there is always the possibility that in response to some vague promise by the Chinese or others to eventually work toward smaller trade surpluses with the USA, Trump could announce victory and end the protectionist policies. A Trump declaration of victory in the tariff wars and eliminating the tariffs would be very bullish for the stock market, even if, in reality, there was no significant change in any trade deficits. The markets would have a relief rally. However, there would still be the risk that Trump could abruptly reverse course and resume the tariffs and trade war.

In my last article focusing on CEFL, CEFL May Be Useful In Some Portfolios, With Its 17% Dividend Yield I said:

...There is also a scenario which could be much more bullish. If Trump were replaced by a President Pence, it would be a dream come true for the business community and the stock markets. It is likely that a President Pence would retain everything that business loves about Trump. These would include the lower business taxes and the reduction of regulation. Appointing judges who tend to favor employers rather than labor would also be a plus for business that Pence would surely retain. While keeping the things that business likes about Trump, Pence would likely remove the thing that corporate America fears and loathes about Trump.

Business and the stock markets would cheer a return to the free trade policies Republicans have traditionally stood for. As Politico reported:

...Pence succeeded his good friend David McIntosh in Congress. Now the president of the Club for Growth, McIntosh has become one of the most outspoken opponents of the administration's tariff decision on the right, calling the policy "an affront to economic freedom."

As governor of Indiana, Pence was a tireless advocate for free trade. He urged the Indiana congressional delegation to support both Trade Promotion Authority and the Trans-Pacific Partnership, which Trump campaigned against. In the letter, Pence argued that "reducing tariffs and other trade barriers so that Indiana businesses can enjoy increased market access and fairly compete on the world stage is something that Congress must do."...

Additionally, the business community and the stock market would likely take comfort in the reduced risk that Trump could take some reckless action that could precipitate military conflict, especially in the Persian Gulf region..."

When that was written in September 2018, there was a possibility that Trump could be removed from office either by impeachment or as with Nixon, the likelihood of impeachment. Such a removal could be the results of findings from Special Counsel Mueller. However, now it appears that there is no reasonable prospect that anything Mueller does or says could result in Trump's removal and replacement by Pence.

Trump famously said, "I could shoot someone on 5th Avenue and not lose any votes". That has now been replaced by "Trump could be caught on videotape handing America's most sensitive military secrets to Russia and still not have any Republican votes for impeachment".

Whatever evidence and proof of criminal acts that Mueller could come up with, it is certain that such evidence and proof could not be as a powerful indication of wrongdoing, as the evidence in the public record that Bret Kavanaugh was lying in the Senate hearings relating to his confirmation as a Supreme Court Justice. Once Christine Ford's account included three people she said were there AND his calendar had them all at Tim Gaudette's house on July 1, 1982, AND Ford's description of the interior of Gaudette's house in Rockville, MD exactly matches that of the actual house, which still exists: the only way that Kavanaugh was not lying is either: Ford somehow obtained access to his 1982 diary/calendar, or Ford has a time machine or Ford stalked Kavanaugh in 1982 and planned to do this, if and when he was nominated to the Supreme Court.

Whatever the outcome of the 2018 midterm elections, it appears Trump will be in office at least until 2020. Right after the 2018 midterm elections, the situation regarding Iran could deteriorate significantly. That is when Trump expects countries to stop importing Iranian oil.

On July 5, 2018, it was reported that Iran explicitly threatened to block the Strait of Hormuz "Any hostile attempt by the U.S. will be followed by an exorbitant cost for them," said Esmail Kowsari, deputy commander of the Sarollah Revolutionary Guards base in Tehran, according to the Young Journalists Club, affiliated with Iran's national broadcaster. "If Iran's oil exports are to be prevented, we will not give permission for oil to be exported to the world through the Strait of Hormuz." Iranian President Rouhani reiterated that threat in a speech on Sunday, July 22, 2018, that also included a warning the United States that any conflict with Iran would be the "mother of all wars."

Not to be outdone, President Trump tweeted:

To Iranian President Rouhani: NEVER, EVER THREATEN THE UNITED STATES AGAIN OR YOU WILL SUFFER CONSEQUENCES THE LIKES OF WHICH FEW THROUGHOUT HISTORY HAVE EVER SUFFERED BEFORE. WE ARE NO LONGER A COUNTRY THAT WILL STAND FOR YOUR DEMENTED WORDS OF VIOLENCE & DEATH. BE CAUTIOUS!11:24 PM - Jul 22, 2018

Military conflict with Iran by the United States could be particularly costly as the major NATO allies may be very reluctant to participate and could even deny the US use of bases and airspace, due to their outrage over President Trump's decision not to certify Iran's compliance with the Nuclear Agreement and other recent statements and actions by Trump. Not only would oil from Iran be shut off. Twenty-five percent of oil traded worldwide moves by tanker through the Strait of Hormuz, the world's most important petroleum transit choke point. A single artillery piece could block the Strait of Hormuz at its narrowest point. No insurance company would ensure any oil tankers that could be subject to visually directed gunfire. Any military conflict involving Iran could thus drastically reduce supply and spike oil prices.

There is also the alternative possibility that Trump is shown to be such a good negotiator that world trade actually increases. That also would be very bullish for the stock market. Trump has stated at times that all elimination of all tariffs, subsidies and trade restrictions should be eliminated. Economists cannot argue with that. However, the chance of Japan allowing the free importation of rice and the European Union ending agricultural subsidies is approximately the same as the probability of the United States allowing domestic American sugar prices to fall to the world market prices. Those probabilities are zero.

Some argue that Trump is merely using threats of tariffs as a negotiating position to ultimately achieve an even better trade system where all tariffs are abolished. This argument, however dubious, cannot be rejected outright. In terms of what Trump really is trying to accomplish Goldman Sachs (NYSE:GS) CEO Lloyd Blankfein pointed out the extent that no one can really know what Trump's true objective regarding trade is when he said about what Trump has done so far regarding trade "That's what you would do if you're crazy and wanted to end free trade," he said. Blankfein also said, "That's what you would do if it was a negotiating position, and you wanted to remind your counterparty just how much firepower you had to bring to the negotiation."

Is The Rationale For My Investment In 2x leveraged High-Yield ETNs Still Intact?

Five years ago in July 2013, I laid out my economics-based rationale for investing in the UBS ETRACS Monthly Pay 2X Leveraged Mortgage REIT ETN (MORL) and mREITs in A Depression With Benefits: The Macro Case For mREITs, which set forth the premise that overinvestment caused by tax policy is the primary driver of the business cycle and that the inequality resulting from the then existent tax code made me a buyer of MORL. That article included in part:

...In free-market capitalism, capital generates income for the owners of the capital which in turn is used to create additional capital. This is very good. Sometimes, it can be actually too good. As capital continues to accumulate, its owners find it more and more difficult to deploy it efficiently. The business sector generally must interact with the household sector by selling goods and services or lending to them. When capital accumulates too rapidly, the productive capacity of the business sector can outpace the ability of the household sector to absorb the increasing production.

The capitalists, or if you prefer, job creators use their increasing wealth and income to reinvest, thus increasing the productive capacity of the business they own. They also lend their accumulated wealth to other business as well as other entities after they have exhausted opportunities within business they own. As they seek to deploy ever more capital, excess factories, housing and shopping centers are built and more and more dubious loans are made. This is overinvestment...

... The Revenue acts of 1926 and 1928 worked exactly as the Republican Congresses that pushed them through promised. The dramatic reductions in taxes on the upper income brackets and estates of the wealthy did indeed result in increases in savings and investment. However, overinvestment (by 1929 there were over 600 automobile manufacturing companies in the USA) caused the depression that made the rich, and most everyone else, ultimately much poorer...

Since 1969, there has been a tremendous shift in the tax burdens away from the rich on onto the middle class. Corporate income tax receipts, whose incidence falls entirely on the owners of corporations, were 4% of GDP then and are now less than 1%. During that same period, payroll tax rates as percent of GDP have increased dramatically. The overinvestment problem caused by the reduction in taxes on the wealthy is exacerbated by the increased tax burden on the middle class. While overinvestment creates more factories, housing and shopping centers, higher payroll taxes reduce the purchasing power of middle-class consumers...

In 2013, the recovery from the financial crisis that began in 2007 was well underway. Many were forecasting that higher interest rates were imminent. My view was that interest rates would stay lower for longer. The was based in part on my view that the Federal Reserve was not artificially depressing short terms risk-free interest rates but rather was prevent them from declining even more. In 2013, I said in Federal Reserve Actually Propping Up Interest Rates: What This Means For mREITs:

...Most investors now believe three things about the Federal Reserve, money and interest rates. They think that the Federal Reserve is artificially depressing rates below what would be a "normal" level. They believe that in the process of doing so the Federal Reserve has enormously increased the supply of money and they believe that the USA is on a fiat money system.

All three of those beliefs are incorrect...

I updated that article on August 23, 2018, with: Federal Reserve Actually Propping Up Interest Rates: What This Means For mREITs: An Update which presented new evidence supporting my original conclusions that the Federal Reserve has been and still is keeping interest rates higher than what a free market in risk-free short-term fixed-income securities would be.

It now appears that the Federal budget deficit will soon be breaking new records. More importantly, it will be the structural deficit causing the new record, rather than the cyclical component that brought the deficit to a record $1.413 trillion in 2009. There are two components of Federal budget deficits: structural and cyclical. The structural deficit can be viewed as what the deficit would be if the economy was at full employment, which would mean that the unemployment rate was at the natural rate of unemployment. This is the rate of unemployment arising from all sources except fluctuations in the overall demand for goods and services. Today the entire deficit is structural, based on the CBO methodology which says that if unemployment is above 4.6%, then the automatic stabilizers kick-in to increase the deficit. Thus, as unemployment increases, tax revenue declines and spending on social safety net programs such as unemployment compensation, food stamps, and Medicaid automatically increase pursuant to existing statutes as more people qualify for benefits. Likewise, when unemployment is below 4.6% the cyclical component actually reduces the Federal budget deficit. Today, at 3.7% unemployment, the entire deficit is structural. In 2009, with double-digit unemployment, there was a significant cyclical component to the deficit.

The relationship between interest rates and the Federal budget deficit has been a matter of concern for many decades. Clearly, borrowing by the US Treasury to finance the deficit tends to put upward pressure on interest rates. A related risk is that, which occurs when the Federal Reserve acts to punish what it perceives as bad government policy, by raising rates. From the late 1970s until, arguably 2007, the Federal Reserve at times, used monetary policy to dissuade politicians from what the Federal Reserve considers profligate fiscal policy. The term "bond market vigilantes" referred to financial market participants who voted with their money against the inflationary impacts of government deficits by selling treasury securities. However, it was usually the Federal Reserve that took on the major role of punishing politicians when it considered fiscal policy too inflationary.

Trump recently said there would be a 10% tax cut after the midterm elections. It probably could pass if it were truly targeted at the middle class. The bad news for my interest sensitive MORL, ETRACS Monthly Pay 2x Leveraged Mortgage REIT ETN Series B (MRRL) and REML positions would be that the additional stimulus of a tax cut when unemployment is already at 3.7% could result in higher levels of economic activity and inflation. That could result in higher market interest rates as well as promoting additional hikes by the Federal Reserve. This could bring some short-term pain. The basis for holding CEFL and the UBS ETRACS 2x Leveraged Long Wells Fargo Business Development Company ETN (BDCL) is to offset the decline in MORL that might occur in a bull market in stocks prompted by higher levels of economic activity.

The good news for MORL holders would be that an overinvestment induced recession, premised in original macro case for mREITs would likely occur earlier. The best time to own agency mortgage-backed securities, mREITs that own agency mortgage-backed securities and especially leveraged portfolios of mREITs such as MORL and REML is when economic weakness causes the Federal Reserve to lower interest rates. The collapse of Lehman in April 2008 caused the Federal Reserve to accelerate the reduction in interest rates already underway from a weakening economy.

My theories regarding monetary policy and the impact on the business cycle resulting from the shift in the tax burden away from the rich and onto the middle class, are the basis for my investment strategy as much now as they were five years ago. Certainly, an overinvestment induced recession caused by the reduction in taxes on the wealthy and exacerbated by the increased tax burden on the some in the middle class has become much more, sooner than later likely as a result of the 2017 tax bill. Thus, a booming stock market rally could hasten the ultimate recession and ideal environment for very interest sensitive securities such as MORL and REML.

What the equity analysts call imprudent use of capital, and I call overinvestment, tends to increase as the business cycle progresses from the recovery phase to the expansionary phase. As the expansion lengthens, overinvestment and lack of discipline in capital allocation would tend to be more prevalent. It's likely that the question of the prospects of a recession in the next five years is more a question of when, rather than if. Thus, I still recommend MORL and REML as well as CEFL. BDCL is still a hold but looks less attractive than CEFL as a diversifier now.

Analysis Of The November 2018 Dividend Projection

While typically called dividends, the monthly payments from CEFL are technically distributions of interest payments on the ETN note based on the dividends paid by the underlying closed-end funds that comprise the index, pursuant to the terms of the indenture. All but three of the CEFL components pay monthly dividends and thus contribute to most of CEFL's monthly dividends. Not included in the CEFL November 2018 dividend projection are: Morgan Stanley Emerging Markets Domestic Debt Fund (EDD). ClearBridge Energy (CEM) and Liberty All Star Equity Fund (USA). They are quarterly payers that will not have any dividends with October 2018 ex-dates. Thus, they will not contribute to the November 2018 CEFL dividend.

USA normally would have an October 2018 ex-date. Thus, it would normally contribute to the November 2018 CEFL dividend. Its' previous third quarter dividends had October 2018 ex-dates. However, because it is conducting a rights offering, the USA third quarter dividend will have a November ex-date. USA has the largest weight in the index upon which CEFL is based. The change to a November ex-date will reduce the November 2018 CEFL dividend by $0.0377 by and increase the December 2018 CEFL dividend by the same amount. That is assuming that USA maintains the same $0.17 dividend as the prior quarter. From the data in the table below, I calculated a projection for the November 2018 monthly CEFL dividend of $0.1709. The table shows the ticker, name, weight, dividend, ex-date, price NAV and contribution to the dividend for the CEFL components that will contribute to the November 2018 CEFL dividend.

Conclusions And Recommendations

Including CEFL in my portfolio of 2x leveraged high-yield ETNs as a diversifier has been relatively expensive when compared to what my total returns would have been if I had held only MORL as compared to a mixture of MORL and CEFL. I have also used BDCL as a diversifier for my MORL holdings.

From the inception of CEFL on January 7, 2014, when CEFL closed at $27.03 to the closing price of $13.63 on October 30, 2018, the total return on CEFL was 17.10%, assuming reinvestment of dividends. Over that 4.81-year holding period, this was an average annual total return of 3.3%. In contrast, over the same period based on the MORL's closing price on January 7, 2014, of $19.95 and the closing price of $14.45 on October 30, 2018, the total return on MORL was 104.45%, again assuming reinvestment of dividends. Over the 4.63-year holding period, that was an average annual total return on MORL of 16.03%.

I have also used BDCL as a diversifier for my MORL, MRRL and REML holdings. That has turned out even worse, relative to simply holding only MORL. Using the 4.81-year holding period BDCL had a total return based on the closing price on January 7, 2014, of $29.83 and the closing price of $13.58 on October 30, 2018, of 3.4%, again assuming reinvestment of dividends. Over the 4.81-year holding period, that was an average annual total return on BDCL of only 0.7%.

Stocks and fixed-income securities, in a sense, compete for shares of investors' portfolios. A decline in the equity market can cause some investors to rebalance their portfolios to shift out of fixed-income securities into stocks. Likewise, a decline in the fixed-income market can cause some investors to rebalance their portfolio and shift out of stocks into fixed-income securities.

I am still cautiously bullish on CEFL as a diversifier for my holdings of 2X leveraged high yield ETNs that are based on mREITs. CEFL is one of the few instruments that provide a very high yield and some ability to benefit from a rising stock market. However, some of the factors that made me bullish previously are not as clear as before. Additionally, policy risks that have arisen as a result of the 2016 election are now becoming more pronounced.

The only other way to achieve a current yield of at least 15% and still be positively correlated to economic activity is with very high yield junk bonds. Obviously, these entail very significant credit risk. For those so inclined, my most recent purchase of a junk bond that probably would do well in a booming economy was the very long maturity bonds of J.C. Penney (JCP) that mature on March 1, 2097. They have 7.625% coupon and at the last price of $46.80 have a current yield of 16.3%. The yield to maturity is also 16.3%. The CUSIP is 708160BL9 for those that are interested.

The vast amount of fiscal stimulus from the growing deficits at this late stage in the business cycle with a 4% unemployment rate raises concerns of an overheating economy. There are reasons to believe that the 4.1% real GDP figure for the second quarter and the latest 4% unemployment rate may not be an accurate indicator of tightness in the labor markets.

As was pointed out in the article, Disability's Disabling Impact On The Labor Market, historically, labor force participation has behaved cyclically in the midst of a slightly declining trend. Dubious and fraudulent disability claims have vastly increased the number of those collecting disability, with commensurate decreases in labor force participation and the unemployment rate.

In the article, REML 21.9% Yield Could Compensate For Many Risks, I discussed the possibility that a rebound in the labor force could alleviate fears of an inflationary labor shortage. As to why this rebound in the labor force may be finally occurring, I suggest that some reforms of the disability system that were included in the 2015 budget agreement may be now having an impact. The surge in number of those collecting disability required a bailout of the disability trust fund that entailed shifting $300 billion from the social security trust fund disability trust fund.

As part of the 2015 budget deal, in return for the disability trust fund bailout that many Republicans opposed, the Obama administration agreed to phase in reforms to the disability system. These included requiring medical evidence in some cases. This was discussed in detail in: Disability And Participation.

The uncertainty of possible impacts from possible protectionism, federal budget deficits, possible overheating in the economy and labor markets and monetary policy suggests large fat-tail risks in both directions in the equity market and fixed-income markets. This would lead investors who have a significant portion of their portfolios in CEFL to consider adding MORL, MRRL or REML to hedge against the risk of much weaker economic growth.

This would enable them to maintain the income in the high teens that CEFL now delivers. Likewise, MORL, MRRL, and REML investors might want to consider adding CEFL or BDCL in order to hedge the against a high real growth scenario. SHMD could be utilized by investors who want to only invest in one 2X leveraged ETN since it contains both interest rate sensitive components and credit risk sensitive components.

The yields on all of the high-yielding 2x leveraged ETNs like CEFL are still compelling. However, the uncertainty regarding economic variables means that significant event risks exist in addition to the risks inherent with the ETN's use of leverage. This is in addition to the leverage employed by many of the components that make up the indices upon which these ETNs are based. I am diversifying the large proportion of MORL in my portfolio with some CEFL and BDCL since there is a small possibility of much stronger economic growth than I expect.

The 2017 tax bill could create a perception on the part of many market participants that there will be much stronger economic growth. This should be considered by shorter-term investors. If something catastrophic were to occur, like severe real protectionism or an oil shock, it would be expected that the stock market would decline sharply, but MORL could do better as investors seek the safety of agency mortgage-backed securities and the Federal Reserve lowers interest rates. There is an unleveraged ETF that is based on the same index as CEFL, the YieldShares High Income ETF (YYY) for those that might want to benefit from a rising market in higher yielding securities but are more risk-averse.

Using data available as of October 31, 2018, the average discount to book value of the 30 high dividend closed-end funds that comprise the index upon which CEFL and its unleveraged version YYY is based was 12.41.%. This compares to the record 13.8% discount to book value for CEFL on September 18, 2015, and the low of 6.9% on July 28, 2016. On January 22, 2018, the average discount to book value of the 30 high dividend closed-end funds that comprise the index upon which CEFL and its unleveraged version YYY is based was 8.55%. Using data available as of December 22, 2017, the average discount to book value of the 30 high dividend closed-end funds that comprised the old index was 7.06%.

A substantial portion of the relative price fluctuation in CEFL is due to changes in the discount to book value. The 12.41% average discount to book value of the 30 high dividend closed-end funds that make up the current CEFL index, is closer to the higher end of the range, that has existed this year. That could suggest a buying opportunity.

A reason for caution, at times, has been that some of the dividends paid by the components of CEFL include return of capital. Because of significant changes in the composition of the index, comparisons of the shares of dividends from return of capital to previous levels may not be very meaningful. Using data available as of October 31, 2018, indicated that 16.3% of the CEFL dividend consisted of return of capital. My calculation using available data as of December 28, 2016, before the 2017 rebalancing indicated that 17% of the CEFL dividend consisted of return of capital.

In view of the uncertainty and risks, active traders might consider waiting until the impacts of the Iran decertification, protectionism, federal budget deficits and monetary policy on economic conditions become more clear. However, a lesson we can learn from the last few years is that waiting for price declines in high-yielding instruments like CEFL, MORL, MRRL, and REML can backfire, as the large dividends forgone by waiting exceeds the savings from a lower purchase price.

Another 2X leveraged ETN from UBS is ETRACS Monthly Pay 2x Leveraged U.S. Small Cap High Dividend ETN (NYSEARCA:SMHD). It started trading on February 3, 2015. It is based on the Solactive US Small Cap High Dividend Index. The yield on SMHD exceeds both CEFL and BDCL and is only slightly less than MORL thus, I am keeping an eye on it and have taken a small long position in it. One interesting aspect of SMHD is that it may be an interesting diversifier for CEFL. This is because closed-end funds are excluded from SMHD. Originally, I looked at SMHD as a diversifier for MORL since SMHD has many equity issues that would do well in an environment of higher levels of economic activity. However, SMHD has a fairly large number of mREITs that are also in MORL. Since SMHD excludes closed-end funds there is no overlap with CEFL.

There are some concerns with SMHD. The tracking fee is a relatively steep 0.85%, as compared to 0.40% for MORL and 0.50% for CEFL. As with any high yielding instrument, there is usually some reason which it is trading at a level that results in a high yield. Thus, many of the components of that are depressed for various reasons. The three largest components of SMHD are: GameStop (NYSE:GME), Spirit Realty Capital Inc. (SRC) and CVR Energy Inc. (CVI).

All of which have had some problems in the past year but are still paying relatively large dividends. The components of the Solactive US Small Cap High Dividend Index upon which SMHD is based are selected based in part of the security's "Forward-Looking Distribution Yield," which is more useful than historical data, but in some cases involves educated guesses as to what the future dividends will be. I will be looking further into SMHD and have taken a position in it.

Presently, CEFL offers a reasonable relative opportunity to diversify a high-yield portfolio with a very high concentration on mREITs. The recent market declines have made all of the 2x Leveraged High Yield ETNs more attractive, as their yields are higher due to the lower prices. My calculation projects a November 2018 CEFL dividend of $0.1709. The implied annualized dividends based on the last three months would be $2.3459. This is a 17.2% simple annualized yield with CEFL priced at $13.63. On a monthly compounded annualized basis, the yield is 18.6%.

If someone thought that over the next five years, equity markets and interest rates would remain relatively stable, and thus CEFL would continue to yield 18.6% on a compounded basis, the return on a strategy of reinvesting all dividends would be enormous. An investment of $100,000 would be worth $235,003 in five years. More interestingly, for those investing for future income, the income from the initial $100,000 would increase from the $18,600 initial annual rate to $43,793 annually.

CEFL Components and Contribution to the Dividend

Name

Ticker

Weight

Price

NAV

Price/NAV

ex-div

dividend

frequency

contribution

Liberty All Star Equity Fund

USA

4.79

5.87

6.4

0.9172

7/26/2018

0.17

q

Eaton Vance Risk-Managed Diversified Equity Income Fund

ETJ

4.67

9.21

9.59

0.9604

10/23/2018

0.076

m

0.0105

Doubleline Income Solutions

DSL

4.45

18.67

20.1

0.9289

10/10/2018

0.15

m

0.0097

Cohen & Steers Quality Income Realty Fund Inc.

RQI

4.32

11.43

12.58

0.9086

10/16/2018

0.08

m

0.0082

Prudential Global Short Duration High Yield Fund

GHY

4.28

13.27

15.91

0.8341

10/11/2018

0.0825

m

0.0072

Blackrock Corporate High Yield Fund

HYT

4.24

9.88

11.41

0.8659

10/12/2018

0.072

m

0.0084

Prudential Short Duration High Yield Fd

ISD

4.22

13.52

16.06

0.8418

10/11/2018

0.085

m

0.0072

Aberdeen Total Dyn

AOD

4.18

7.82

9.26

0.8445

10/18/2018

0.0575

m

0.0084

Blackrock Multi-Sector Income

BIT

4.15

16.25

18.76

0.8662

10/12/2018

0.1167

m

0.0081

Eaton Vance Limited Duration Income Fund

EVV

4.12

12.25

14.46

0.8472

10/10/2018

0.067

m

0.0061

Wells Fargo Advantage Income Opportunities Fund

EAD

4.11

7.54

8.78

0.8588

10/12/2018

0.061

m

0.0090

Western Asset High Income Fund II

HIX

4.04

6.09

7.06

0.8626

10/18/2018

0.0455

m

0.0082

Nexpoint Credit

NHF

4.03

21.55

24.22

0.8898

10/22/2018

0.2

m

0.0102

Nuveen Credit Strategies Income Fund

JQC

3.96

7.69

9.04

0.8507

10/12/2018

0.0385

m

0.0054

Western Asset Emerging Markets Debt Fund

EMD

3.85

12.49

14.88

0.8394

10/18/2018

0.1

m

0.0084

Morgan Stanley Emerging Markets Domestic Debt Fund

EDD

3.84

6.19

7.29

0.8491

9/27/2018

0.15

q

Invesco Dynamic Credit Opportunities Fund

VTA

3.81

11.01

13.07

0.8424

10/15/2018

0.0625

m

0.0059

PIMCO Dynamic Credit Income Fund

PCI

3.75

22.48

23.54

0.9550

10/11/2018

0.1641

m

0.0074

Western Asset Global

EHI

3.31

8.72

10.25

0.8507

10/18/2018

0.061

m

0.0063

Blackstone/GSO Strategic Credit Fund

BGB

2.95

14.89

16.74

0.8895

10/23/2018

0.105

m

0.0057

First Trust High Income Long/Short Fund

FSD

2.84

14

16.51

0.8480

10/1/2018

0.105

m

0.0058

Western Asset High Income Op

HIO

2.6

4.54

5.32

0.8534

10/18/2018

0.0265

m

0.0041

Brookfield R A Incm

RA

2.48

21.19

23.33

0.9083

10/16/2018

0.199

m

0.0063

Clearbridge Energy

CEM

2.39

12.42

13.58

0.9146

8/23/2018

0.355

q

BlackRock Credit Allocation Income Trust

BTZ

1.9

11.7

13.71

0.8534

10/12/2018

0.067

m

0.0030

AllianceBernstein Global High Income Fund Inc.

AWF

1.68

11.09

12.94

0.8570

10/4/2018

0.0699

m

0.0029

Blackrock Debt Strategies Fund Inc.

DSU

1.56

10.65

12.32

0.8644

10/12/2018

0.0685

m

0.0027

Invesco Senior Inc.

VVR

1.37

4.14

4.89

0.8466

10/15/2018

0.0195

m

0.0018

Nuveen Real Asset

JRI

1.08

14.98

17.53

0.8545

10/12/2018

0.106

m

0.0021

Eaton Vance Tax Ad D

EVT

1.02

21.96

22.56

0.9734

10/23/2018

0.145

m

0.0018

Disclosure: I am/we are long CEFL, MORL, MRRL, REML, SMHD.

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.