An 18% Dividend Yield? What Could Go Wrong? (SMHD)

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UBS Group AG (USA) (NYSE:UBS) just launched its latest leveraged exchange-traded note (ETN) designed to capitalize on the opportunities in small-cap dividend stocks.

UBSThe long-titled Etracs Monthly Pay 2xLeveraged US Small Cap High Dividend ETN (NYSEARCA:SMHD) is designed to provide monthly compounded 2x exposure to the Solactive US Small Cap High Dividend Index — a basket of about 100 small-cap stocks that pay high dividend yields. Currently, that includes top holdings such as LinnCo LLC (NASDAQ:LNCO) and Denbury Resources Inc. (NYSE:DNR).

According to the UBS Etracs website, this ETN (which is just an unsubordinated debt instrument) has an index dividend yield of 17.7%, and income is paid monthly to shareholders. In addition, the underlying portfolio leverage is reset monthly instead of daily to improve SMHD’s tracking efficiency.

Little bit of leverage, truckloads of monthly income … SMHD sounds like fun, right?

While I’m all about maximizing dividends given the prevailing interest rate and equity market environment, SMHD or any vehicle of this nature is really only appropriate for institutional or aggressive investors. This is not a knock against ETNs, UBS (the fund sponsor) or any aspect of the underlying index. Rather, it has more to do with taking an appropriate amount of risk for the consummate expected return.

One mantra that income investors should always remember is that high dividend yield = high risk. There is no such thing as a free lunch when it comes to balancing the spread between a credit-risk-free U.S. Treasury bond and a high-yield security of any variety.

I have been a staunch advocate of investors shying away from leveraged vehicles of this nature because they magnify price changes in both directions. The majority of investors I come in contact with typically have a conservative or moderate risk tolerance that would make an investment of this nature unsuitable for their needs. They simply wouldn’t sleep well at night knowing that their hard-earned nest egg is susceptible to wild swings in value despite the commensurate higher dividend yield.

While not nearly as exciting in terms of leverage or dividend yield, the WisdomTree SmallCap Dividend Fund (ETF) (NYSEARCA:DES) may make a more suitable alternative for traditional portfolios seeking out a diversified equity-income play. DES has exposure to 737 small- and mid-cap companies — such as Vector Group Ltd (NYSE:VGR) and Theravance Inc (NASDAQ:THRX) — with histories of paying dividends to shareholders.

The index is fundamentally weighted toward those stocks that are paying the highest aggregate income, which coalesces to generate a 30-day SEC yield of 2.39%.

DES is more geared toward investors seeking commonplace small-cap correlation with the added benefit of monthly distributions.

Bottom Line

While leveraged ETFs and ETNs might have high risk, they still are beloved by many traders with a thirst for big gains. If you do decide to invest in these products, make sure that you do so with a risk management plan that includes a stop-loss. That way you are able to define your capital at risk and make an unemotional exit if conditions don’t prove to be favorable at that time.

In my opinion, those that are retired or seeking a more conservative approach to the market should shy away from the temptation to use these vehicles in their portfolios. Instead, stick with a more balanced asset allocation that includes multiple asset classes to reduce overall volatility and enhance your income streams.

David Fabian is Managing Partner and Chief Operations Officer of FMD Capital Management. To get more investor insights from FMD Capital, visit their blog.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/02/18-dividend-yield-go-wrong-smhd/.

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