Looking for a New Income ETF? Try This ETN from ETRACS

Zacks Equity Research
November 15, 2013

ETRACS, the ETF brand from the Switzerland-based bank UBS, has already made waves in the multi-asset space. After launching a multi-asset ETN – ETRACS Diversified High Income ETN (DVHI) – in September, this issuer of exchange traded products has now unveiled a leveraged form of the same note. The new product will trade under the name of ETRACS Monthly Pay 2xLeveraged Diversified High Income ETN -DVHL.
Multi asset ETFs – focused on investing in a blend of diverse asset classes such as investment grade and high yield bonds, stocks, preferred stocks, REITs and MLPs –have caught investor attention lately thanks to the erratic movements in the global economy in the past few months. The market is likely to stay volatile in the coming months as well mainly due to ongoing speculations over taper timing and its impact on interest rates and key stock markets.
The product is capable of safeguarding investors against excessive fluctuations in the market and offering capital appreciation while lowering downside risks by investing in a pool of assets that are not highly correlated. Also, endowing investors with a very high level of current income by adopting a double-leverage approach is another purpose of the product (read: Senior Loan ETFs: The Best Bet for Rising Rates?).
DVHL in Focus

This new note looks to offer investors two times monthly resetting exposure to the NYSE Diversified High Income Index. The index consists of a diversified portfolio of 138 high income-generating securities around the world that historically pay significant dividends or distributions.
The product anticipates paying out roughly 13.63% in yield a year to investors, indicating its heavy focus on income. In terms of equity sector allocation that covers almost 60% of the fund, business development companies and energy MLPs take up the top chunk each getting 15% share. Another asset class fixed income including preferred stocks, emerging market bonds, high yield bonds and muni bonds accounts for 10% of share each.
Investors should also note that the product is structured as an ETN which carries an associated risk of the issuer’s credit worthiness, though this should be a minor consideration.

How does it fit in a portfolio?

The investors looking for a broad income play across the asset classes may want to consider this product. Dividend ETFs have gained popularity in recent years owing to the rock-bottom interest rate scenario currently prevailing in the market.

Even though dividend stocks and funds fall out of favor in a rising rate environment mainly during taper concerns, dividend investing is still a wise bet. This is due to the fact that historically as much as 40% of market returns came from dividends.

And when it comes to dividend investing, MLPs and REITs steal the show as these firms must pay out at least 90% of their earnings to holders for favorable tax treatment  (read: 3 ETFs that Maximize Shareholder Value).

Moreover, due to the monthly resetting nature of this leveraged ETN, the product may prove ideal for the medium-term investors who can avoid extreme volatility faced from the products having daily resetting nature (read: Time to Buy Floating Rate ETFs?).

Can it succeed?

In terms of competition, the multi-assets high-yield space has a great deal of products striving for investor money. Some of the most impressive competitors include the Guggenheim Multi-Asset Income ETF (CVY), First Trust Multi-Asset Diversified Income Index Fund (MDIV) and iShares Morningstar Multi-Asset Income Index Fund (IYLD). All three have at least $100 million in assets under management with CVY leading the pack with around $750 million in assets accumulation, so far.

From the yield point of view, the trio offers yields of 5.43%, 5.87% and 2.38% respectively (as of November 13, 2013). This is the area in which DVHL is likely to outperform its high-yield cousins. An add-on 2x leverage to an already high-income ETN might entice yield-seeking investors going forward and can provide DVHL an edge over most of its counterparts.

The new ETRACS product could attract considerable interest from traders not having a long-term view. A decent level of capital appreciation and current income can be expected from the product despite global market uncertainty. Just remember, leveraged products can be quite risky, so make sure to have a strong stomach before consider this new high income ETN.

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