Back on December 20th of 2019, I wrote an article here on Seeking Alpha titled, “MORL: Double Yield And Double Annualized Volatility“. Just yesterday, I received a message from a loyal follower who wanted to know what his options were on owning this product. For a moment, I actually forgot I had written a story on the Etracs product a few months back. I was truly amazed at how many subscribers were following MORL, and amazed at how many individuals said in comments that they owned other ETNs for their high-yields. This article is not to take a victory lap over the collapse of MORL, but to further help and educate investors who do not understand how exchange traded products work. If you currently own an ETN in your portfolio, you must review the prospectus today, or better yet, don’t buy them at all.
ETNs Are Not The Same As ETFs
The UBS ETRACS Monthly Pay 2x Leveraged Mortgage REIT ETN will be a case study for financial engineers to discuss for a long-time. Many investors purchase shares in products like MORL or MRRL, believing that they are owning an open-ended mutual fund, or even an exchanged traded fund. However, you are purchasing a senior, unsecured, debt security issued by an underwriting investment bank. Similar to other debt instruments, ETNs have a maturity date and are backed only by the credit of the issuer. The problem and catch with ETNs, is they are traded on an exchange just like an ETF, but they don’t actually own any underlying assets of the indices or benchmarks they are designed to track. This is the core problem to any ETN. Even though investors are urged to read the prospectus to any investment, most do not.
The Collapse In MORL Shares
With most investors hooked on coronavirus news and trying to stay healthy, the news of the MORL and MRRL collapse has slipped through the financial news. Just a few months ago, the 2x REIT products had hundreds of millions under management. Today, it’s hard to say how many millions are left:
MORL has dropped over 95%, as the exponential daily compounding of daily returns has killed the value of this note. As we all know, we are seeing a current ‘run’ on liquidity across all asset classes, like we haven’t seen since the Great Financial Crisis of 2008. Investors and traders have been selling anything they can, especially underlying REIT securities, which the MORL product has been tracking with twice the leverage:
At one point, the MORL product had over $400 million in assets under management. Now with just $3.37 million under management, the note will more than likely be redeemed by UBS.
Acceleration Upon Minimum Indicative Value
When going back to the original product supplement of MORL on UBS’s website, an investor can find language on what happens once the security has lost more than 60% of its value. Let’s take a look at what UBS states in the product supplement below:
If, at any time, the indicative value for any series of the Securities on any Trading Day (1) equals $5.00 or less or (2) decreases 60% in value from the closing indicative value of that series of the Securities on the previous Monthly Valuation Date (each such day, an “Acceleration Date”), all issued and outstanding Securities of that series will be automatically accelerated and mandatorily redeemed by UBS (even if the indicative value of that series would later exceed $5.00 or increase from the -60% level on such Acceleration Date or any subsequent Trading Day during the applicable Measurement Period) for a cash payment equal to the Acceleration Amount.
Since the security has dropped below the $5.00 mark, the security should be redeemed by UBS.
This explanation was pulled right from the product supplement on the UBS Etracs website, where they fairly disclosed what would happen if the security were to suffer such rapid loss. However, investors owning these types of products are usually too caught up in the product summaries instead of the product supplements. Instead of focusing just on the yield, the price, and transaction costs, investors need to review such documents. If for any reason, you are confused by the description and risks mentioned in the supplements, you should always consult an investment and or legal professional for help.
The Risks Going Forward
We are in a bear market that most investors thought we could never be in. Where cash is king, products such as MORL are becoming toxic assets by the day. From credit risk, to call risk, to the leverage decay, these products are asking for long-term trouble. Very large yield figures will always attract capital. However, most investors do not consider how the note is achieving this ultra-high yield, and what the impacts are when the index drops due to a bear market environment. Any investor who owns these types of notes, should stop reading immediately and review the prospectus or supplement tied to their ETN.
If you own any security that has 2x leverage to any asset class, such as MORL or MRRL, you should really reconsider why you own such a product. Markets are likely to experience more severe volatility from uncertain economic developments from the coronavirus. With such a complex structure with contango and backwardation risks, the average investor should not own these type of products, period. If you are an investor looking to earn outsized returns from such a sell-off like we are experiencing today, I urge you to look for other more traditional assets in doing so.
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.