UBS rolled out the latest addition to its rapidly-expanding ETN lineup this week, adding a 2x leveraged version of the business development company ETN it debuted just last month. The E-TRACS 2x Leveraged Long Wells Fargo Business Development Company ETN (BDCL) will deliver monthly results that correspond to 200% of the monthly change in a benchmark comprised of publicly-traded companies that are generally involved in lending money to small and mid-sized companies, often establishing equity stakes in the companies as well.
ABCs Of BDCs
In order to qualify as a BDC, an entity must be must be registered in compliance with Section 54 of the Investment Company Act of 1940; many publicly-traded private equity firms have done just that. In order to maintain BDC tax status–which allows entities to enjoy the same benefits as REITs and pay almost no corporate taxes–these companies are required to pay out substantially all of their earnings as distributions to shareholders. As such, BDCs often feature attractive distribution yields; the payout for many firms is in excess of 8% [see Under The Hood Of New BDC ETN]. Currently, the annual yield on the underlying Wells Fargo Business Development Company Index is about 7.8%, translating to an annual leveraged yield on BDCL of about 14.6%.
That hefty distribution yield is, of course, not without considerable risk. While the BDCs that make up the underlying index are publicly-traded companies, the securities in which they invest are privately-held corporations, many of which are start-up firms or speculative firms that are not yet generating positive cash flow. BDCs are essentially an indirect investment in a portfolio of small, privately held firms through a variety of different vehicles, including 1st Lien Senior Debt, 2nd Lien Senior Debt, Senior Subordinated Debt, Senior Secured Loan Program, and equity. As such the valuation of these portfolios can exhibit significant volatility; when liquidity dried up during the recent financial crisis, some private equity firms saw the value of their portfolios decline by as much as 85% in a matter of months.
BDCL is the 20th ETN on the UBS platform; the company also offers a 2x ETN linked to the Alerian MLP Infrastructure Index; MLPL also offers an annual leveraged yield in excess of 10% (currently coming in at about 11.6%).
Disclosure: No positions at time of writing.