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UBS Rolls Out Leveraged US Small Cap Dividend ETN

Concerns related to dividend ETFs are evident, given higher chances of the Fed hiking interest rates sooner than expected in the U.S. Yet, income ETFs draw enough attention thanks to persistent global turmoil (read: 3 ETFs Yielding Over 6% to Watch as Market Speculates Rising Rates ). There are plenty of options in this space too, as a number of providers launched new dividend ETFs over the past few months. While the space is definitely jam-packed, UBS – a leader in exchange-traded notes – discovered room for yet another play in the leveraged dividend ETF space. Consequently, the company rolled out a new income fund namely ETRACS Monthly Pay 2xleveraged US Small Cap High Dividend ETN (NYSEARCA: SMHD ) targeting the U.S. small-cap space. Inside SMHD This ETN looks to follow two times the monthly performance of the Solactive US Small Cap High Dividend Index. This benchmark consists of 100 high dividend yielding small cap U.S. firms. Top holdings for the ETN’s underlying index include LinnCo LLC (NASDAQ: LNCO ) (5.98%), Denbury Resources (NYSE: DNR ) (5.75%) and Peabody Energy (NYSE: BTU ) (5.22%), all of which account for over 15% of the note. In terms of yield, the index pays about 17% per annum (as of February 3, 2015) to investors, a pretty solid level. And for such a smart exposure, the cost does not seem steep as the product charges 85 bps in fees, which is lower than the average expense ratio charged by the leveraged equity ETFs. As far as country exposure is concerned, the product puts about 93.6% of assets in the U.S. followed by Bermuda (5.3%) and United Kingdom (1.1%). Investors should note that the product carries the credit risk of UBS AG (NYSE: UBS ) attached to it, though the issuer is considered a high-rated and sought after financial institution. How Does it Fit in a Portfolio? This ETF is an intriguing choice for investors seeking a new take on income investing. It could also be appropriate for investors seeking to ride out the U.S. growth momentum amid global meltdown and earn substantial yield as the domestic economy seems set to hike the key interest rates this year. Notably, given the currency concerns and global turmoil, small-caps appear better bets than large caps when it comes to investing in the domestic arena. After all, these pint-sized equities revolve around the domestic economy more than the large caps, which normally have a wider foothold abroad (read: Investor Guide to Small-Cap Value ETFs ). On the other hand, the ETN does not look to be a pricier option giving investors another reason to bend towards it. Plus, a monthly rebalancing strategy is a winning criterion in the leveraged space as many other products rebalance on a daily basis, enhancing the risk quotient in the product (read: UBS Launches New Monthly Resetting Leveraged ETF ). Meet the Competitors The leveraged high yield space is still not chockablock. Among the trendy and coveted ones, UBS itself operates two products namely UBS ETRACS Monthly Pay 2x leveraged Dow Jones Select Dividend Index ETN (NYSEARCA: DVYL ) and UBS ETRACS Monthly Pay 2x leveraged S&P Dividend ETN (NYSEARCA: SDYL ) . While SDYL targets a monthly 2x version of the 50 highest dividend yielding firms in the S&P Composite 1500 Index and DVYL focuses on the Dow Jones U.S. Select Dividend Index which screens by the dividend per share growth rate, dividend payout percentages, and average dollar trading volume, and then selects on the basis of dividend yield. SDYL has an asset base of $21.9 million and charges 30 bps in fees while DVYL has so far amassed about $33 million in assets and charges about 35 bps in fees. SDYL yields 4.45% in dividends annually (as of February 13, 2015) and DVYL yields 6.50%. Considering these options, the small-cap concept is fresh in the leveraged equities ETF space and should not face much problem in hoarding investors’ money. Though the product is priced higher than the issuers’ older offerings, a novel theme and a substantially higher yield opportunity should more than compensate for increased costs.

Preliminary Fed Report Says Don’t Fear Leveraged ETFs

By Mark Melin Leveraged and inverse ETFs, which have come under heavy criticism as potentially exacerbating volatility in financial markets, are not the danger that critics have made them out to be, concludes a preliminary study from U.S. Federal Reserve researchers. In their white paper, ” Are Concerns About Leveraged ETFs Overblown ,” Fed researchers Ivan T. Ivanov and Stephen L. Lenkey make the case that concerns in this regard are exaggerated. To the contrary, the authors assert that “capital flows considerably reduce ETF rebalancing demand and, therefore, mitigate the potential for ETFs to amplify volatility.” (click to enlarge) Opposition to the leveraged ETFs Initial opposition to the leveraged ETFs was strong. In fact, as The Wall Street Journal’s Pedro Nicolaci Da Costa notes, both the Securities and Exchange Commission and the Fed had issued warnings regarding leveraged ETFs. In fact, at one point the SEC had issued a moratorium on approving exemption requests for new leveraged and inverse ETFs, typically a serious sign of trouble from regulators. The primary point of concern focused on what the report said was a common “perception” that the process of re-balancing leveraged and inverse ETF portfolios exacerbated performance. If the ETF was experiencing positive returns, the conventional thinking was leveraged ETFs distorted prices higher. More concerning to market observers was the notion that if the ETF experienced negative price movement, leverage would then amplify market moves lower in price. It is at this point that researchers Lenkey and Ivanov disagree. “Such reasoning is incomplete because it overlooks the effects of capital flows,” they note in their white paper, characterizing concerns regarding these products are “likely exaggerated.” (click to enlarge) Leveraged ETFs capital diminishes the potential to exacerbate volatility The paper asserts that capital coming in and out of a leveraged ETF diminishes the potential to exacerbate volatility. This is because capital flows occur frequently and tend to offset the need for ETFs to rebalance their portfolios. A key conclusion is that ETF rebalancing demand is strongest when returns are large in magnitude, which is important because ETFs would presumably be most prone to amplify market movements in these cases. The report, however, relies on the stock market recovery to offset negative asset from a market crash. “The large decline in the value of the S&P 500 during 2008-09 leads to a large capital inflow. This results in more assets under management for the ETF relative to the benchmark case with no capital flows. Then, as the index recovers, the ETF undergoes a greater amount of rebalancing on a day-to-day basis because it has more assets under management.” Several market watchers, including hedge fund manager Carl Icahn, have raised concerns that the next market crash could involve derivatives more destructive than the 2008 crash, leading to a more difficult recovery, a recovery model that the authors did not model. Read the full report here . Disclosure: None