Leveraged Dividend ETFs: Too Good To Be True?

By ETFDatabase | June 20, 2012 AAA

Investor interest in dividend-paying stocks has generally surged over the past two years, as the combination of climbing volatility and record low interest rates has sent investors flocking towards equities that offer meaningful current returns. The vehicle of choice for many pursuing this objective has been ETFs; there are now some four dozen exchange-traded products that target dividend stocks, with billions of dollars in AUM between them. Many dividend ETFs feature yields that are not substantially greater than broad-based equity products. The Vanguard Dividend Appreciation ETF (VIG), for example, has an annual dividend yield barely north of 2%and roughly in line with the S&P 500 .

But there are several exchange-traded options for investors seeking more substantial dividends. A relatively new innovation has been the development of ETNs offering leveraged exposure to high yielding asset classes, including dividend-paying stocks, MLPs, and Business Development Companies. This suite of ETNs includes some of the highest yielding securities available to U.S. investors, and features several double digit yields .

Monthly Leverage 101

While leveraged ETNs have obvious appeal to yield hungry investors, they carry some obvious (and substantial) risks as well. Exposure to the underlying securities is amplified in both directions, meaning that any potential losses will be multiplied as well. While the meaty dividend yields on these securities will translate into attractive current returns, that component will often be dwarfed by the gains or losses associated with the capital appreciation (or depreciation) of the underlying securities.

The ETNs highlighted below offer leveraged exposure on a monthly basis, meaning that the multiple is reset once per month. That's a big difference from the leveraged ETFs that reset exposure on a daily basis. Monthly leveraged ETNs seek to amplify the returns generated by an index over the course of a month, regardless of the volatility experienced by that index during the course of the month. Daily leveraged ETFs, on the other hand, can (and often do) deliver returns that differ dramatically from the daily target multiple times the performance of the underlying index during the course of a month.

If the value of the asset class represented by these products generally appreciates over a prolonged period of time, these monthly leveraged ETNs can generally be expected to post pretty impressive gains. But if prices move in the opposite direction, losses will be amplified as well.

In other words, monthly leveraged ETNs generally won't feature the same degree of risk and volatility that are characteristic of daily leveraged ETFs. These types of securities may appear to be similar on the surface, but are actually quite different in terms of the risk profile and return opportunities.

Leveraged Dividend ETNs

For investors with the stomach for a fair amount of risk, there are a number of leveraged ETNs that can deliver impressive yields:

  • ETRACS Monthly Pay 2x Leveraged S&P Dividend ETN (SDYL): This ETN is linked to an index comprised of the 50 highest dividend yielding constituents of the stocks of the S&P Composite 1500 Index that have increased dividends every year for at least 25 consecutive years. Components include AT&T, Abbott Labs, and Clorox.
  • ETRACS Monthly Pay 2x Leveraged Dow Jones Select Dividend Index ETN (DVYL): This ETN is linked to an index which screens stoks by dividend per share growth rate, dividend payout percentage rate, and average daily dollar trading volume, and stocks are selected based on dividend yield. Components include Lockheed Martin Corporation, Chevron Corporation, and Kimberly-Clark Corporation.
  • ETRACS 2xLeveraged Long Wells Fargo Business Development Company ETN (BDCL): This ETN is linked to an index which is intended to measure the performance of all Business Development Companies that are listed on the New York Stock Exchange or NASDAQ.
  • E-TRACS 2x Leveraged Long Alerian MLP Infrastructure Index (MLPL): This ETN is linked to an index designed to give investors exposure to the infrastructure component of the Master Limited Partnership asset class.
  • ETRACS Monthly Pay 2x Leveraged Dow Jones International Real Estate ETN (RWXL): This ETN is linked to an index representing international equity real estate investment trusts and real estate operating companies, excluding those in the United States.
ETN Name Leveraged Yield 1x ETP
SDYL ETRACS Monthly Pay 2x Leveraged S&P Dividend ETN 6.96% SDY
DVYL ETRACS Monthly Pay 2x Leveraged Dow Jones Select Dividend Index ETN 7.90% DVY
BDCL ETRACS 2xLeveraged Long Wells Fargo Business Development Company ETN 18.71% BDCS
MLPL ETRACS 2x Leveraged Long Alerian MLP Infrastructure Index 10.71% AMLP, MLPI
RWXL ETRACS Monthly Pay 2x Leveraged Dow Jones International Real Estate ETN 7.60% RWX

Disclosure: Long BDCL.

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