Double Dividend Funds? Slow Down!

by Kyle Woodley | May 24, 2012 12:45 pm

Greed sure brings out the opportunist in people.

The investing world is rife with scams. Ponzi, fake gold, even fake offers to buy Facebook (NASDAQ:FB[1]) stock before the IPO (which might have lost you less than actually investing in FB after the IPO). But perhaps just as bad as a dishonest-to-God illegal scam is a sleazy-but-still-by-the-book offering.

Enter stage right: UBS (NYSE:UBS[2]) and its two new leveraged dividend products.

While interest in dividends and fixed income has picked up speed in recent years, the past two months especially have seen some hot movement out of traditional equities and into securities like defensive stocks and bond funds[3]. All you have to do is take a look at the weekly lists of new exchange-traded product launches[4] to see that yield is the new black.

However, the reason most people are piling into utilities, Treasuries and the like — stable income, security against a volatile market — is what makes UBS’s latest products come off as downright slimy. Namely, they throw a risk wrench into the anti-risk machinery.

The products in question are the Etracs Monthly Pay 2x Leveraged Dow Jones Select Dividend Index ETN (NYSE:DVYL[5]) and Etracs Monthly Pay 2x Leveraged S&P Dividend ETN (NYSE:SDYL[6]).

Here are the basics: Both are weighted by annual dividend — DVYL’s index looks at five years of dividend history, while SDYL’s considers 25 years. DVYL tracks about 100 securities, with a top weighting of around 4% and a maximum weight for any single stock of 10%. SDYL tracks 60 components, with a top weighting of 3.7% but a much smaller cap of 4%.

Both will distribute cash monthly at 2x the distribution of their benchmarks, though it’s possible that a month could go by without any index component making a payout — meaning no check to you. UBS says the Dow fund will charge 0.35% in fees and the S&P fund 0.3%.

Just like anyone peddling exchange-traded products, UBS has written down its caveat emptor[7] disclosures for all to see. But in case you don’t want to wade through all the technical speak, I’ll break down the important aspects for you:

• Good: You have the chance to make double the returns and dividends (minus fees) of either the Dow Jones Select Dividend Index or the S&P High Yield Dividend Aristocrats Index.
• Bad: You also have the chance to lose double the returns (minus fees) of either the Dow Jones Select Dividend Index or the S&P High Yield Dividend Aristocrats Index. Worse: DVYL and SDYL are exchange-traded notes, not funds[8], which means they don’t actually hold the equities — they’re merely debt securities that track an index. Thus, a knock to UBS’s credit rating actually could affect them, even if their benchmarks are doing just fine.

If you’re a sophisticated, seasoned trader, bully for you — you should have plenty of fun with these guys.

However, if you’re just a regular Joe who’s a little worried about Europe, China, even the sustainability of the U.S. recovery, and you just want to slowly but surely grow the money in your account, don’t be sucked in by the high-wattage light.

Leveraged funds, while completely legitimate products, are riddled with high risk[9] and marketed with the temptation of high rewards. In the specific cases of DVYL and SDYL, the large-cap nature of the funds means even the magnified day-to-day vibrations won’t be too extreme, but if the market bites, you’ll really be on the hook.

Instead, if you’re looking for stable income, you’d be better off chasing traditional dividend funds that actually hold securities, such as the iShares Dow Jones Select Dividend (NYSE:DVY[10]) ETF, which is based on the same index that DVYL tracks. (DVY itself has had a lackluster 2012, gaining just 1.7%, but it sports a solid 3.5% yield.)

Even non-dividend-focused funds rife with blue chips — such as the SPDR Dow Jones Industrial Average ETF (NYSE:DIA[11], 2.5% yield) and iShares Morningstar Large Value (NYSE:JKF[12], 3% yield) — can throw off significant income.

But always keep in mind when targeting ETFs for yield that, like dividend stocks, you have to consider future capital gains and losses. In other words, DVY’s nearly 3.5% yield is fantastic, but it essentially could be negated if the fund itself loses enough value.

So always do your research and make sure you’re confident in the actual holdings of whatever fund you plan to buy.

Kyle Woodley[13] is the assistant editor of InvestorPlace.com[14]. As of this writing, he did not hold a position in any of the aforementioned securities. Follow him on Twitter at @KyleWoodley[15].

Source URL: https://investorplace.com/2012/05/double-dividend-funds-slow-down/

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