is about a month away from its first anniversary but has already solidified its reputation as the highest yielding U.S.-listed ETP. MORL’s monthly distributions to owners totaled nearly $1.30 per note during the most recent quarter. Given its current trading price of about $19.20, this places the current yield of MORL on the north side of 27%. Not too shabby, especially in today’s yield-starved world.
There is risk with anything yielding more than the near-zero “risk-free” rate of T-Bills. Therefore, it is imperative for investors to understand these risks before diving in. Here is my analysis of MORL:
MORL’s underlying Market Vectors Global Mortgage REITs Index is a float-adjusted, market-capitalization weighted index of publicly-traded mortgage REITs. Although “global” is part of its name, the index currently has more than a 99% U.S. allocation. Index constituents currently having more than a 5% weighting include Annaly Capital Management Inc (NLY) 16.2%, American Capital Agency Corp (AGNC) 12.4%, Starwood Property Trust Inc (STWD) 5.6%, Chimera Investment Corp (CIM) 5.1%, Two Harbors Investment Corp (TWO) 5.1%, and MFA Financial Inc (MFA) 5.1%. There is a high degree of risk with mortgage REITs, and they are currently in a bear market.
Monthly Leverage Reset
MORL is linked to the monthly-compounded 2x leveraged performance of the underlying index (overview page). Both its price and distributions are subject to this leverage, magnifying the effects of price swings and payments. Resetting the leverage monthly instead of daily mitigates the volatility decay but does not eliminate it. Total return since inception has been -11.0% versus -3.3% for the non-leveraged Market Vectors Mortgage REIT Income ETF (MORT), which tracks the same index. Drawdowns are also more severe, with MORL’s price dropping 48.3% this summer versus the 26.4% price drop of MORT.
Early Termination Triggers
Monthly versus daily reset increases the likelihood of a catastrophic price move because the probability of the underlying index falling 50% during a calendar month is much higher than for any given day. Therefore, MORL will invoke anti-ruin automatic acceleration and redemption (early termination triggers) in the event the indicative value drops to $5.00 or decreases 60% in value between monthly resets. See the fact sheet (pdf) and other documents for additional details.
As an exchange traded note, MORL is a senior, unsecured, unsubordinated debt security of UBS. The notes carry the credit risk of UBS and do not mature until 2042. However, these ETNs can be created or redeemed on a daily basis at full NAV, which is one of the defining features of ETFs and ETNs. Therefore, the credit risk is similar to a security maturing in a day or two, instead of one with a 30-year maturity.
MORL pays monthly but not evenly. According to the distribution history, each quarter consists of a large payment in the first month followed by much smaller payments the remaining two months. For example, the most recent quarter consisted of a $1.1045 coupon in July, $0.1062 for August, and $0.0884 in September. The $1.2991 total for the quarter was down from $1.5631 in the second quarter and $1.4638 in the first quarter. This is also a good reminder that payment amounts are not guaranteed.
As detailed in the Pricing Supplement (pdf), MORL has a tracking fee of 0.40% and a financing rate based on three-month LIBOR plus a spread of 0.40%.
There are a few ways for investors to think about portfolio risk when holding MORL. If MORL is able to maintain its current quarterly $1.30 payout, then you should get 100% of your investment back in just four years independent of what happens to the price.
If you are holding a portfolio of T-Bills yielding zero, you can boost your portfolio level yield to more than 1% by holding a mixture of 96% T-Bills and 4% MORL. You could double the 2.8% yield of a 10-year Treasury portfolio by allocating 12% of it to MORL.
MORL is now trading 33% below its April 30 peak. It can always go lower, but today represents a much lower risk entry point than just a few months ago. MORL is a high-risk security with an extremely tempting yield. There are many ways for investors to manage this risk, including the approaches outlined above. As with most things, moderation is key.
This article is brought to you courtesy of Ron Rowland from Invest With an Edge.