A Fund That Yields 25%? Calm Down.

by Kyle Woodley | October 18, 2012 2:00 pm

File this under “handle with care.”

Back in May, UBS (NYSE:UBS[1]) hopped onto the yield-seeking train by launching a pair of leveraged exchange-traded notes that offered “double dividends.”[2] This week, however, UBS has upped the ante by entering the high-income world of real estate investment trusts — entities that have to pay out a minimum of 90% of taxable income to shareholders — and offering an ETN that it says could yield (brace yourself) … nearly 25%.

Calm down.

The ETRACS Monthly Pay 2x Leveraged Mortgage REIT ETN (NYSE:MORL[3]) is a debt-backed security that essentially will offer you double exposure to the Market VectorsGlobal Mortgage REITs Index. In this case, that means pretty heavy exposure to Annaly Capital Management (NYSE:NLY[4], 19%) and American Capital Agency (NASDAQ:AGNC[5], 14.5%), along with another 20 or so mortgage REITs.

By UBS’ calculations based on end-of-September data for the Market Vectors index, the ETF could produce a yield of 24.82%.

If that doesn’t have massive warning bells ringing in your ears, it should.

While leveraged funds aren’t inherently evil, I can’t help but wince a little bit when these complex trading products (meant for sophisticated traders) are combined with high-yield assets (meant for long-term investors). If you’re the latter, please be advised — these funds come with the myriad risks a 25% yield rightfully should carry.

For one, the “leveraged” aspect of the fund alone offers the opportunity for big-time gains, and similarly, the opportunity for big-time losses. If the index tanks, your “investment” tanks twice as much.

Also, MORL is rebalanced monthly, so you’re getting double exposure merely to what MORL does in a month, then the process essentially starts back at square one. In layman’s terms, if you intend on holding something like this for five to 10 years to collect income (you shouldn’t), you’re not going to get perfectly double exposure to the index over than period.

By the way, that “leverage” comes from the fact that MORL and other like products aren’t actually funds holding securities. They’re debt-backed securities, which means that if the actual financial institution (UBS) backing the securities fails, you could be left holding air. Plus there’s risks connected with how units of these ETNs are issued, which you can read more about here[6].

That’s not to mention the risks in following the asset class itself. REITs themselves sometimes use leverage to buy mortgages, which makes them highly sensitive to interest rates[7] – especially in the case of rapid changes in rates. For perspective, the Market Vectors Mortgage REIT Income ETF (NYSE:MORT[8]) tracks the same index and offers a juicy 9% yield in compensation for merely the risks inherent in the sector. MORL offers more than twice that. Imagine what you’re buying into.

There’s money to be made in MORL, no question, but it’s not the steady income sought by long-term buy-and-holders — even if the headline yield can’t help but draw them in.

Kyle Woodley[9] is the Assistant Editor of InvestorPlace.com[10]. As of this writing, he did not hold a position in any of the aforementioned securities. Follow him on Twitter at @IPKyleWoodley[11].

Endnotes:
  1. UBS: http://studio-5.financialcontent.com/investplace/quote?Symbol=UBS
  2. leveraged exchange-traded notes that offered “double dividends.”: http://investorplace.com/2012/05/double-dividend-funds-slow-down/
  3. MORL: http://studio-5.financialcontent.com/investplace/quote?Symbol=MORL
  4. NLY: http://studio-5.financialcontent.com/investplace/quote?Symbol=NLY
  5. AGNC: http://studio-5.financialcontent.com/investplace/quote?Symbol=AGNC
  6. which you can read more about here: http://investorplace.com/2012/03/volatility-etn-tvix-rears-its-ugly-head/
  7. highly sensitive to interest rates: http://investorplace.com/2012/07/should-you-sell-mreits-before-rates-rise/
  8. MORT: http://studio-5.financialcontent.com/investplace/quote?Symbol=MORT
  9. Kyle Woodley: http://www.investorplace.com/author/kyle-woodley/
  10. InvestorPlace.com: http://investorplace.com/
  11. @IPKyleWoodley: https://twitter.com/#!/kylewoodley

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