Notes tied to total return, dividend-paying indexes attract buyers for cost efficiency, yield

By Emma Trincal

New York, June 26 - Investors are flocking to dividend-paying products, sources said, pointing to a general market trend, and signs show that structured product buyers are no exception.

In some cases, investors use notes linked to total return indexes in a bid to obtain ease of access to an asset class at a lower cost, often as a substitute for an exchange-traded fund. In other instances, especially with exchange-traded notes, investors simply are seeking as much yield as possible, sources said.

"Everybody is looking for more yield. It's definitely the case with income clients, but there is demand across the board," said Scott Cramer, president of Cramer & Rauchegger, Inc.

"We'll see more and more of this trend. If I was a financial company, I would be packaging more and more products that give access to dividend yields.

"We hear from clients all the time 'I want yield. My CD is giving me nothing. I'm willing to get into stocks in order to get more yield.'"

Shan Lan, head of global equity index and ETF research at Deutsche Bank, said in a recent research report that investors are looking for products that offer low volatility and higher dividends as a response to a market characterized by choppy prices and low interest rates.

"To the extent that people are going to put money in the market, it's going to be in dividend-yielding securities. I definitely see a trend," a New York structured products sellsider said.

"Investors are cautious. If they're going to invest, they're thinking about dividend distribution potential. That's why you're seeing that dividend trend," he said.

Delta one

The largest deals so far this year (excluding ETNs) have been notes linked to total return indexes, according to data compiled by Prospect News. Some buysiders believe that the trend reveals investors' search for yield.

UBS AG, London Branch priced last month the top non-ETN deal of the year so far, a $946.2 million issue of 0% Fisher enhanced big cap growth securities due May 28, 2013 linked to the Russell 1000 Growth Index Total Return. The notes, callable and putable, offer at maturity par plus double the sum of the index return minus an adjustment factor. There is a redemption fee upon an early redemption.

But a market participant said that the use of total return indexes, which include dividend distribution, has little to do with the appetite for yield.

"Just because something is tied to a total return index doesn't mean that people buy it for dividends," this market participant said.

"This is a delta one product. It has no optionality. Whenever you do a delta one or a tracker, if you will, you take the total return.

"This large offering is a big institution making a discretionary portfolio allocation. Usually they have a lot to invest. Whenever a pension fund or an asset manager wants to make an allocation, they have the option of using a note. That's what they did here."

The second-largest deal of the year so far is also a tracker.

On May 25, HSBC USA Inc. priced $171.82 million of 0% notes due June 14, 2013 linked to the MSCI Daily Total Return Net World index. The payout at maturity will be par plus the index return, with exposure to any losses.

"The size of those deals reveals something that's actually very positive for our industry," the market participant said.

"In the past, when a discretionary manager wanted to get exposure to an asset class, they used to do it themselves, for instance they would buy the stocks or they would use an ETF or a mutual fund. Today, they can actually use a structured product to get that delta one exposure in a more efficient way, and there can be less fees than a mutual fund or an ETF if the structured note issuer is more efficient in the pricing. And they can be."

Dividend mania in ETNs

In the ETN market, the search for yield is a more obvious trend.

"Some yield-hungry investors are buying some of those dividend ETNs for the yield. That's what those products are designed for," the market participant said.

"If prices are not going anywhere, people come to the conclusion that at least they can get the dividend and that it can add up if they hold it for a certain period of time."

UBS recently launched two separate ETNs that pay a monthly coupon reflecting the dividend distributions of their respective underlying indexes.

The new exchange-traded access securities provide leveraged access to the dividend yield of two popular dividend-related indexes.

The firm in May priced $10 million of monthly pay 2x leveraged ETracs due May 22, 2042 linked to the Dow Jones U.S. Select Dividend index with a plan to sell up to $100 million of the notes.

This index is designed to track the return of 100 stocks selected by dividend yield, subject to screens for dividend-per-share growth rate, dividend payout ratio and average daily trading volume.

Separately, UBS also priced $10 million of monthly pay 2x leveraged ETracs due May 22, 2042 linked to the S&P High Yield Dividend Aristocrats index with a $100 million shelf.

The index measures the performance of the 60 highest-dividend-yielding S&P Composite 1500 index constituents that have followed a managed-dividends policy of consistently increasing dividends every year for at least 25 consecutive years.

Both products pay a monthly coupon. In both cases, the coupon is twice the sum of the cash distributions, if any, made on the index constituents during the relevant period.

MLP success story

Another indication of the appetite for yield expressed by ETN investors is the popularity of JPMorgan Chase & Co.'s ETNs linked to the Alerian MLP index.

This product and some of JPMorgan's competitors' versions in the same asset class have offered investors a way to tap into the high-yielding master limited partnership space with some advantageous tax treatment.

Earlier this month, JPMorgan said that it capped the issuance at $2.46 billion.

As of June 14, JPMorgan has issued a total principal amount of $2.24 billion, according to a 424B2 filing with the Securities and Exchange Commission. The ETN, which is listed on the NYSE Arca under the symbol "AMJ," began trading three years ago with $75 million.

One additional factor behind the strong volume of the MLP ETN is the product's tax implications, the sellsider said.

"ETNs don't have double taxation on MLPs, which can improve returns. Unlike the ETF that owns the MLPs, the ETN doesn't own the equity interest and therefore there is no taxation at the entity level. That's why there is no K1 associated with a MLP ETN. It's a 1099," he said.

"In terms of outstanding volume by asset class, commodities and MLP equity ETNs come ahead of volatility ETNs," said Bernd Henseler, vice president of structured products at Standard & Poor's.

"However, in asset class distribution by 30-day average trading volume, volatility is by far the most active."

MLP equity ETNs represent 28.6% of the outstanding ETN volume, according to Bloomberg. Commodities make for 36.1% of the outstanding volume, while volatility represents 25.1%.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.