Excellent 16% Distribution Yield with Significant Capital Appreciation Delivered

The UBS ETRACS Monthly Pay 2xLeveraged Closed-End Fund ETN (NYSE Arca: CEFL) is a dollar-denominated exchange-traded note that deploys 1:1 leverage and gives investors twice the upside to monthly-compounded total returns of the underlying ISE High Income Index, less accrued fees.

16.3% Distribution Yield, 10% Capital Appreciation

CEFL makes monthly distributions and currently yields 16.13% based on its closing price of $29.88 (as of July 3, 2014). Year-to-date, CEFL has paid distributions of $2.3103 and is expected to pay $0.61 in July, its highest monthly dividend ever.

In addition to its rich distribution yield, CEFL investors have seen the ETN rise 10.5% year-to-date. The ETN has 5.25 million shares outstanding and has a market capitalization of about $156.5 million.

Expect Record July 2014 Distribution Due to Leverage and Rising NAV

Of the 30 CEF constituents in the ISE High Income Index, nine pay dividends quarterly and 21 pay them monthly. Of the nine quarterly payers, eight went ex-dividend in June 2014 and will be included in the July 2014 CEFL monthly distribution. But even though the underlying constituents have not raised dividends, CEFL is expected to pay a distribution of $0.61 per note in July 2014, up 2.7% from the $0.5941 paid in April 2014 and the highest since inception. The reason for the expected increase in distribution is an increase in the NAV and the purchase of additional underlying funds to maintain 2x leverage.

On the flip side, a falling NAV could cut into dividends relative to the underlying Index but that is a risk investors should be willing to bear for higher upside.

ETN and Underlying Index – Well Diversified, Top Ranked Index Constituents

This ETN is issued by investment bank
UBS (which has a solid investment grade rating), with borrowings (for leverage) from UBS itself. The 30-year ETN was initiated on December 10, 2013, and matures 12/10/2043. Borrowings by the ETN are senior, unsubordinated and unsecured.

The underlying ISE High Income Index is sponsored by the International Securities Exchange and reflects a diversified portfolio of 30 top income-generating closed-end funds (closed-end funds, or CEFs, issue a fixed number of shares and are regulated by the Investment Company Act of 1940.)

The ISE High Income Index ranks funds in descending order based on three factors – yield, share price discount relative to net asset value and trading liquidity – and includes the top 30 closed-end U.S. funds in the Index that also meet minimum market capitalization and liquidity requirements. The Index’ constituents include CEFs managed by top names such as AllianceBernstein, Allianz/PIMCO, BlackRock, Calamos, Clough, Eaton Vance, First Trust, ING, Nuveen and Wells Fargo.

The Index favors higher-ranked funds and gives them a higher weighting, but is rebalanced every year to ensure that constituent weightings do not exceed index targets. The index is a price return index and cash distributions are reflected in the variable monthly coupon that may be paid to CEFL investors.


Through borrowings, the ETN gives investors double the exposure to CEFs than they’d get from a straight investment without borrowings. This double exposure results in double the distributions, less accrued ETN and accrued interest expenses. Therefore, leverage provides attractive returns.

CEFL has an annual tracking rate of 0.50% per annum and bears interest at 3-month LIBOR + 0.40% per annum.

Investment Benefits – Solid Income, Diversified Underlying CEFs

CEFL offers significant monthly income potential through its variable coupon that is linked to twice the cash distributions of the Index constituents through 2x leveraged exposure to an index of 30 top U.S. closed-end funds that vary by asset class, investment strategy, asset manager and investment region. The closed-end funds are selected, in part, for their discounts to NAV; therefore, CEFL offers potential for price appreciation as the constituent CEFs rise to meet their NAV. The monthly leverage reset feature, as opposed to daily resets, also favors CEFL ETN investors while offering the high-liquidity stock-like convenience of an exchange-traded security.

Investment Risks – Leverage is a Double-Edged Sword

With its 2x leverage, investors could also face a 2x monthly decline in the level of the Index and in distributions. Investors could also lose capital if they opt for early redemption or if the monthly compounded leveraged return is not enough to cover accrued fees and early redemption penalties. And, as with all ETNs, CEFL may not accurately mirror the ISE High Income Index at all times. Further, adverse losses in one month
may not be adequately recovered by outperformance in subsequent months (simply because a 50% loss on $100 requires a 100% gain to breakeven). UBS, the underwriter, may redeem all outstanding ETNs after 12/14/2014, at settlement amounts that could be less than the principal invested.

A leveraged long investment involves borrowing money, along with investor capital, to purchase assets (Index constituents) and terminates with the sale of the underlying assets and repayment of debt with proceeds. With a focus on discounted CEFs, this ETN hopes that the increase in the value of underlying assets will exceed the cumulative interest on borrowings over the term of the loan.


The UBS ETRACS Monthly Pay 2xLeveraged Closed-End Fund ETN (NYSE Arca: CEFL) has delivered excellent distribution yield through well-designed leverage. It has also delivered solid year-to-date returns because of investments in CEFs that trade at a discount to NAV. And the upcoming July 2014 distribution is expected to be the highest to date, far above distributions on the underlying Index. However, high volatility, high interest rates and a drop in Index value could crimp capital gains and distribution levels so investors should carefully consider inherent risks.

I believe this is a suitable holding for an investor seeking high yield income. Rising interest rates can cause financial risk to this security. An investor should know the legal ramifications of an “ETN”. ETN stands for Exchange Traded Note. This risk is accepted or not accepted by each individual investor’s risk tolerance.

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