Eric Dutram: In investors’ never ending quest for payouts in today’s low rate environment, many have looked beyond traditional high yield locations to more ‘exotic’ locales for income. These often include funds or securities that target segments like MLPs, junk bonds, or more recently, REITs.
REITs have become particularly popular as of late as the real estate market has seemingly bottomed out making securities in this segment a relatively low risk way to obtain yield. This is especially true given the structure of REITs as they are required to pay out at least 90% of their ordinary income on a regular basis, making them top picks for income investors (see 11 Great Dividend ETFs).
Yet while REITs are increasingly in focus, some investors may be better off looking at the mortgage REIT market for truly impressive yields. These companies raise capital, usually via loans, and then acquire longer term mortgage based assets and profit off of the spread between the two.
While there are some concerns over a tightening spread thanks to QE3, a situation that would undoubtedly hurt profits for mREITs, the fact remains that these are among the biggest yielders on the market today. Furthermore, the QE3 program isn’t all bad news for mREITs, as it does look to keep borrowing costs very low for the foreseeable future, keeping this side of the equation stable for these firms (read Are QE3 and Mortgage REIT ETFs a Winning Combo?).
Still, even with some of these concerns, the real promise of this space is the yield, as evidenced by the two ETFs in the market,REM and MORT. Both of these funds pay out truly impressive yields with both topping 11% on an annual basis, making them very interesting picks for yield focused investors.
If that wasn’t enough, UBS seeks to offer up a new ETN in the space which looks to crush all comers in the high yield mREIT market with their ETRACS Monthly Pay 2x Leveraged Mortgage REIT ETN (NYSEARCA:MORL). This new product will charge investors just 40 basis points a year but it will offer up, thanks to the 2x leverage, a yield of 24.8% (based on two times the Index yield calculated as of September 30, 2012 by Market Vectors), making it unquestionably the top income destination for investors.
This will be done using an ETN structure so that the product will not actually hold any securities but instead will promise to pay out a return equal to the underlying index. While this eliminates tracking error, it does expose investors to the small risk of UBS as it is an unsubordinated debt instrument of that financial firm (read Invest like the One Percent with These Three ETFs).
Furthermore, it is also worth pointing out that this note utilizes monthly leverage instead of the more ‘traditional’ daily rebalancing system. While this obviously means that it will be more volatile than an unleveraged counterpart, the monthly rebalancing means that the ‘decay’ that most experience in daily resetting funds will not be as much of an issue with this mortgage REIT focused ETN.
This note actually tracks the same index that is the basis of MORT, except this one uses leverage. In terms of holdings, Annaly Capital Management (NYSE:NLY) and American Capital Agency Corp. (NASDAQ:AGNC) combine to account for over one-third of assets, suggesting that the product is heavily concentrated, especially considering that it only holds 22 other securities in its basket.
While the new note certainly sounds intriguing, we will have to see if the extreme volatility that is likely in this product outweighs the truly astounding yield that will be available to investors in MORL. If the volatility isn’t too extreme, we could see a push to this note from investors who are seeking outstanding yields in this low rate environment (see Three Overlooked High Yield ETFs).
After all, with the ten year T-Bill hovering around the 1.8% level, MORL’s projected yield approaching 25% sounds truly incredible. Whether investors are willing to stomach the high volatility and potentially low volume (and wide bid ask spreads) for this yield though, remains to be seen. Either way, MORL looks to be an exciting product and interesting development for the broad ETF industry as a whole.
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