Leveraged High Dividend ETNs
Introduction
UBS and Credit Suisse offer 2x leveraged ETNs that are designed to track indexes associated with high dividend securities like MLPs, BDCs, REITs and others. What is unique about these ETNs is that they also pay dividends linked to the dividends of the underlying indexes. A leveraged 2x ETF, by contrast, pays dividends only when it has net investment income or capital gains related to its buying and selling of swaps and other derivatives. Such "incidental" dividends are usually fairly nominal, or are unpredictable.
Because of the leverage, these ETNs have really high dividend yields:
| Name | Symbol | Last price | Currency |
|---|---|---|---|
| ETRACS 2xMonthly Pay Leveraged US Small Cap High Dividend ETN | ARCX:SMHB | 5.25 | USD |
| ETRACS 2xMonthly Pay Leveraged Preferred Stock Index ETN | ARCX:PFFL | 9.33 | USD |
| ETRACS 2X HI DIV L-VOL ETN-B | ARCX:HDLB | 13.36 | USD |
Risk discussion
Normally, it is difficult to contemplate having a long-term investor put any kind of leveraged ETP in their portfolio, as the risk is too great. But in many respects, these high dividend ETNs represent a special class of ETP that require special consideration. Should a long-term investor consider putting one of these high yielding ETNs in their portfolio?
These ETNs are difficult to analyze. Since they are leveraged 2x ETNs, the market prices will be subject to huge swings up and down. So they are definitely risky investments. But with a dividend yield greater than 10%, one of these may be an attractive long-term investment, particularly if you hold it in a tax-free account like an IRA. For example, if you hold one of these ETNs for 10+ years, you will receive all of your initial investment back in the form of dividends, so even if the market price falls by 50%, you will have made positive investment.
These type of high yielding, leveraged ETNs are only a few years old, so there is no long-term track record. They are both tempting and controversial at the same time.
Perhaps the biggest risk with buying one of these ETNs is that the bank won't stay in the ETN business long enough for an investor to execute a long-term investment. In other words, buying an ETN with a dividend yield > 10% would probably be a good long-term investment, if you can hold onto it for a long time. But the bank may close this ETN at any time or even exit the ETN business all together. If you are forced to liquidate your investment, the market value of your investment may have dropped significantly, especially due to the 2x leverage factor. Market corrections happen all the time, so you have to be careful with any leveraged ETN.
Make sure you fully understand the basics of how an ETN works.
These leveraged ETNs are also difficult to analyze because many of them are linked to special security types like REITs, MLPs, BDCs and mortgage REITs. It is fairly well accepted that REITs as an asset class perform pretty well, usually as well, if not better, than the U.S. stock market as a whole. But it is unclear how well these other asset classes perform over long periods of time. So these leveraged ETNs are often leveraging an asset class that is difficult to understand.
Financing fees
Many of these leveraged ETNs include a "financing fee" as well as a normal management fee. So you have to read carefully the ETN's fee disclosures to understand what fees you are paying. The financing fees are usually fairly small compared to the margin interest rates most investors would pay to their broker to achieve an equivalent 2x leverage themselves using a margin account.
Conclusion
Everyone has a different opinion about whether to use leverage or not. The risks are great. Investors have to focus on the underlying asset class and the underlying index. The first question to ask is whether the index is a good one or not? Do you want to leverage a bad index?