The New UBS Mortgage REIT Leveraged ETN - Taking Risk to Dizzying Heights


At Index Funds Advisors, Inc. we have consistently warned investors away from the complex financial products put out by the large Wall Street firms. Most of the "innovation" that occurs in finance is only for the benefit of the issuing companies and is often harmful to retail investors. A perfect example is the newly introduced 2x leveraged mortgage REIT exchange-traded note from UBS which is touted to have a yield of 24.8%, an incredibly generous number in today's world of extremely low interest rates. There are so many potential problems with this security that it is hard to know where to begin.

First, it is an exchange-traded note rather than an exchange-traded fund, which means that it is merely a promise by the issuer (UBS) to deliver a 2x multiplier of the return of a mortgage REIT index. There are no underlying securities to back up the notes in the event that UBS becomes insolvent. Potential investors could argue that they are not worried about this scenario because when UBS ran into trouble during the financial crisis of 2008, it was bailed out by the Swiss government.  Nevertheless, the fact that UBS has been fined by FINRA for misleading retail investors about the risks of Principal-Protection Notes and fined by the SEC for fraudulently rigging municipal bond reinvestment transactions in 36 states should give pause to potential investors. (See UBS: A Rotten Culture Inspires Rotten Actions for more details.)

Second, it is a leveraged exchange-traded product which means that the returns realized by investors could be very different than the returns they anticipate, particularly if they hold it for longer than a month. FINRA has issued repeated warnings to investors about the dangers of leveraged and inverse exchange-traded products and has levied fines against brokers for selling them to clients for whom they were not suitable.

Third, the underlying index (Market Vectors Global Mortgage REITs Index) includes many companies that are leveraged six to ten times. This means a hapless buyer of this ETN would be exposing himself to leverage on top of leverage! A discussion of the underlying problems with mortgage REITs (which should not be confused with equity REITs) may be found in Reaching for Yield: High-Yield Mortgage REITs. The essential point is that the profitability of mortgage REITs requires a spread between short-term and long-term interest rates, and if this spread compresses, investors can be completely wiped out.

IFA reminds yield-hungry investors that higher yields are only achieved with risk, and a 24.8% yield means a very large helping of risk. Wise investors will steer clear of this hazardous innovation from Wall Street.