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Why DB’s Hedged Brazil ETF Yields 12%

Dennis Hudachek

Last Thursday, ETF.com posted an article about the five highest-yielding ETFs. Immediately, the first one on the list, the db X-trackers MSCI Brazil Hedged Equity ETF (DBBR | D-42), jumped out at me.

The article listed DBBR with a 12.3 percent yield. When I looked up DBBR in our ETF Finder, it showed the fund does in fact have a trailing 12-month (TTM) distribution yield close to 12 percent.

But don’t be fooled by the fund’s “juicy yield,” as there’s much more to the story behind this yield.

DBBR’s “yield” over the past year has more to do with gains from its forward-currency contracts than dividends paid from its underlying holdings. Brazilian securities are actually yielding closer to 4 percent.

The fund’s “portfolio yield” is 3.87 percent, roughly in line with the iShares MSCI Brazil Capped ETF’s (EWZ | C-98) 3.93 percent yield. This doesn’t surprise me, since DBBR tracks a very similar MSCI index as EWZ, simply with a forward-currency contract overlay.

12 Percent Yield Calculation

We calculate our TTM distribution yield by taking all the distributions from the fund (including income, short-term and long-term gains) over the past 12 months and dividing that by the fund’s current net asset value (NAV).

According to Deutsche’s website, DBBR made a huge “ordinary income” distribution of $1.82142 on Dec. 27, 2013, but made no distributions on July 10, 2014 (DBBR makes semiannual distributions).

If you divide $1.82142 by $14.81 (the fund’s NAV on the day the data was pulled, July 2, 2014), you get 0.12298, which gives DBBR this 12.3 percent yield.

Now here’s the real kicker. If this yield were pulled a few days earlier—before DBBR traded ex-dividend on June 27, 2014—the yield for DBBR would have shown as 20 percent!

That’s because DBBR traded ex-dividend a year earlier on June 27, 2013, and paid out $1.16533 a share on July 10, 2013. Combining this distribution with the massive distribution in late December 2013 would have given you a 12-month total distribution of $2.98675.

So, if you divide $2.98675 by $14.96 (NAV on June 26, 2014), you get 0.199649, or 20 percent. Voila!

Now that we know the calculation behind this yield, let’s dive into why DBBR paid out such massive distributions in 2013 even though its constituents are yielding “only” 3.87 percent.

Forward-Currency Contract Gains

Interest rates in Brazil are sky-high at 11 percent, but DBBR hedges out its exposure to the Brazilian real by selling one-month forward contracts. In essence, the fund is “short” the real in the same notional value as the fund’s assets, neutralizing currency exposure.

As most of us are aware, when you’re “short” a security, you’re on the hook for dividend payments. The same is true of being “short” a forward-currency contract, only that the contracts have a negative embedded yield—in the case of the real, that’s roughly 10 percent.

That’s a pretty steep and expensive hedge. The embedded negative yield basically gets taken out of the fund’s NAV.

Meanwhile, the Brazilian real got crushed in 2013 relative to the dollar by more than 15 percent.

BRL-USD Cross
BRL-USD Cross

Source:Bloomberg

Since DBBR is technically “short” the real through its forward contracts, this all amounted to some hefty gains in those contracts, most of which were distributed.

That’s the real secret behind DBBR’s massive distributions in 2013.

In the coming year, unless we have another banner year for the dollar/real cross, it’s unlikely DBBR will produce a yield anywhere near the 12-20 percent range.

The point of this blog isn’t so much about the investment merits of DBBR; it’s really about understanding yield, and how currency-hedged ETFs work.

Yield can mean different things, and there are many ways to calculate yield. Even if the displayed yield is correct, it’s good to understand what that yield means and how the yield was calculated before assuming that it’s the yield you’ll get from owning shares in the fund today.

At the time this article was written, the author held no positions in the securities mentioned. Contact Dennis Hudachek at dhudachek@etf.com, or follow him on Twitter @Dennis_Hudachek.

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