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Closed-End ETFs: New Leveraged High Yield Choice from ETRACS

Zacks Equity Research

ETRACS, the fund brand from the Switzerland-based bank UBS, is gradually gaining popularity in the high income space. After launching multi-asset ETNs like ETRACS Diversified High Income ETN (DVHI) in September and ETRACS Monthly Pay 2xLeveraged Diversified High Income ETN (DVHL) in November, this issuer of exchange traded products has now come up with yet another leveraged product.
The new product will trade under the name of ETRACS Monthly Pay 2xLeveraged Closed-End Fund ETN – CEFL and give investors diversified exposure to the closed-end fund space (read: A Better Yield ETF? UBS Launches High Income ETN).
The market is likely to stay volatile in the coming months mainly due to taper concerns. In a worst case scenario, CEFL is capable of safeguarding investors against excessive market fluctuations by investing in a pool of assets that are not highly correlated. Also, awarding investors with a very high level of current income through a double-leverage approach is another positive for the product.
CEFL in Focus
This new note – launched on December 11 – looks to offer investors two times monthly compounded exposure to the ISE High Income Index. The index consists of a diversified portfolio of 30 U.S.-based closed-end funds. These component funds are chosen on the basis of their income yield, their discount from NAV and liquidity.
The product anticipates paying out roughly 19.0% in yield a year to investors, indicating its focus on income. Equity sector allocation covers almost 60% of the fund yielding about 9.56% followed by debt-driven funds (about 25.0%) yielding about 10%. The remaining 15% goes to several other high income asset classes (see all the ETFs in the CEF space here).
Since CEFL looks to track various funds, the information about the issuers of those funds is important. Eaton Vance takes up the top chunk (28.71%) while Blackrock (27.09%) and Nuveen (11.40%) form the subsequent two positions of the index.
Currently, CEFL’s top holdings include Eaton Vance Enhanced Equity Income Fund II, Eaton Vance Tax-Managed Diversified Equity Income Fund, and AllianzGI NFJ Dividend, Interest & Premium Strategy Fund – all accounting for about 4% plus share of the total. 
Investors should also note that the product is structured as an ETN which carries an associated risk of the issuer’s credit worthiness. Further, being a high income product, the underlying bond holdings of the note do not posses very high credit rating, thus calling for higher default risks.

How does it fit in a portfolio?

The product is suitable for investors who are looking for a broad income play across the asset classes. Income producing ETFs have gained popularity in recent years owing to the rock-bottom interest rate scenario currently prevailing in the market (see 3 High Quality Dividend ETFs to Buy This Holiday Season).

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

Future Competition

The high-yield space is actually pretty crowded already. ETRACS itself has gone for a handful of product launches in this space this year, with subtle differences between each. However, most of these products are open-ended unlike CEFL. So, the real challenge for CEFL will come from its close-ended high-income peers.

There is only one newly-launched fund tracking the same ISE High Income Index though with unleveraged exposure – YieldShares High Income ETF (YYY). The High-income close-end space also has some renowned names including PowerShares CEF Income Composite Portfolio (PCEF) – managing an asset base of about $450 million and Market Vectors CEF Municipal Income ETF (XMPT) (read: YieldShares Launches New High Income ETF).

From the yield point of view, the trio offers a yield of 5.21%, 8.35% and 6.35% respectively (as of December 13, 2013) while CEFL is likely to yield an impressive 19%. This makes CEFL a far more enticing option for yield-seeking investors than its other close-ended cousins.

The second area of strength is in the expense ratio of the product. CEFL charges investors a very low 50 bps in expenses while other above-mentioned products charge not less than 1.65% to investors. Quite expectedly, the product garnered $24.6 million in AUM within just two days of launch and is expected to continue its run in the months ahead, though volatility could be extremely high with this product.

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