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This article was first released to CEF/ETF Income Laboratory subscribers 1 month ago, so data may be out of date. Please check latest data before making investment decisions.
In our latest ETRACS 2x Leveraged ETN Snapshot, we updated the dividend growth rate [DGR] section to include calendar 5-year DGRs, which are possible for the 3 2x ETNs incepted in 2012 (DVYL, SDYL and MORL) since they now have 6 full years of distributions available (2013 to 2018 inclusive). This was something that I could have done at the start of this year, but for some reason I forgot to do so.
Here’s the chart again from the article showing the 1, 3 and 5-year DGRs for all of the ETNs. I’ve also included a data table at the bottom in case you want to see the exact numbers. For the 5-year DGRs, we see a very large divergence between DVYL and SDYL on one hand, which both boosted distributions by an average of 16% per year over 5 years, and MORL, which reduced its payout by -10% per year over 10 years.
In this article, I’d like to examine the dividend histories of these three ETNs in a bit more detail. The following chart shows the annual dollar/share amounts paid out by these 3 2x ETNs from 2013 to 2018. We can see that DVYL and SDYL’s payout have consistently gone up each year, while MORL’s has mostly gone down each year (except for 2016 which was the lowest out of the 6 years).
Here is the same data but presented in terms of the percentage change in the annual payout, using 2013 as the base. We can see that over 5 years, DVYL and SDYL have increased their annual payouts by 113% and 112% respectively, while for MORL, the 2018 payout is -41% lower than in 2013.
The next chart shows the cumulative payout by these ETNs. We can see that while MORL paid over twice as much as DVYL and SDYL during the first full year of their existences, the cumulative distributions from DVYL already eclipsed MORL in 2018, and it may only be a matter of time until SDYL catches up as well.
Why is there such a large difference in the distribution growth rates of these 2x ETNs? This is another good place to remind members that the distributions of the 2x ETNs are not only affected by the yield of the underlying holdings, but also changes in price of the ETNs. This is because the index has to buy more stocks to maintain the leverage when the underlying goes up, but also vice versa as well.
This is apparent when comparing the DGR of DVYL and SDYL with their unleveraged counterparts, DVY and SDY. We can see that the distributions of 2x ETNs have ramped up much more quickly than their 1x counterparts over the last 5 years, with around twice the DGR.
What is the purpose of looking at these numbers? The obvious conclusion that one would have done better to choose DVYL and SDYL over MORL in 2012 for distribution growth is not helpful. After all, hindsight is 20/20 – and it cannot be denied that the superb performance of U.S. stocks over the last 5 years have been a boon to the dividend growth rates of DVYL and SDYL. If the U.S. stock market had been flat over the last half-decade, we could very well have seen the DGRs for these two ETNs halved. It is therefore very important to remember again that the dividend growth rates of these 2x leveraged ETNs can vary greatly depending on how well the underlying index does.
I believe that a more relevant message for today’s investor is to not only be fixated on the headline yield number, no matter whether one is looking at ETNs, ETFs or even CEFs. A popular, but somewhat simplistic, formula used by many investors when considering the attractiveness of a high-yield instrument is the “rule of 72” (or more accurately, the rule of 69.3147…). This rule helps you to calculate the number of years, N, required for an investment yielding Y% to double in value, where N = 72/Y. In other words, if an investment yields 6%, it would take 72/6 = 12 years for it to double, while if an investment yields 10%, it would take 72/10 = 7.2 years for it to double.
What this rule fails to take into account is two important things: (1) that distributions can fluctuate, and (2) more importantly, that share prices can fluctuate. Both of these would affect the number of years required for an investment to double.
Take MORL for instance, which was incepted on October 17, 2012 with a headline yield of 24.82%. According to the rule of 72, this investment should only take 2.9 years to double (2.8 using the rule of 69.3) with dividends fully invested. Instead MORL took until June 17, 2017, or 4.7 years, to double, which is over 60% than what the rule of 72 predicted.
Am I saying that MORL was a bad investment? Hardly! A double in under 5 years is still a very impressive performance (though less so when you consider the 2x leverage). And please also note that there is no guarantee that MORL will double again in 5 years from now.
What I am saying is to keep in mind the fact that since these ETNs are 2x-leveraged, the future payouts of these instruments can vary greatly depending on how well the underlying index performs. So definitely don’t count on a steady yield from these instruments for your retirement, rule of 72 or not!
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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