Betting on a Long, Hard Slog

 | Apr 24, 2012 | 10:00 AM EDT  | Comments
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BDCL

If you formed your opinions based solely on the headlines in the financial press, you'd think that there are only two possible scenarios in the current environment. The first possibility is that equities are extremely undervalued and headed for a tremendous surge, and U.S. jobs engine is now firing on all cylinders and pushing the economy higher. The other is that the U.S. is on the brink of a double-dip recession that's going to send prices for risky assets tumbling -- and the mounting debt burdens around the globe and crises in Europe are going to swallow up global equity markets. Seemingly, there is no in-between.

It's easy to come up with a long list of actionable investment ideas for either of those scenarios. There are a number of high-volatility products that should perform well if risk appetite remains strong and numerous safe havens, and bear ETFs that should be expected to post solid gains if the U.S. head back into recession. What's a bit more challenging is picking out asset classes that can deliver superior risk adjusted returns if a more likely scenario plays out -- a long, slow road to recovery, marked by steady growth in jobs and gross domestic product but with ongoing anxiety over the numerous risks dotting the landscape.

The UBS E-TRACS 2x Leveraged Long Wells Fargo Business Development Company ETN (BDCL) -- which may have one of the longest names in the exchange-traded universe -- is the latest addition to my all-ETF portfolio. I'm of the belief that the U.S. is on the road to recovery, and that the next few years will be relatively good to risky assets. With that in mind, BDCL offers a way to amplify exposure to an asset class that should thrive during a recovery, while paying out a yield that almost seems too good to be true.

BDCL offers monthly leveraged exposure to an index comprising business-development companies (BDCs), firms that generally maintain a portfolio of privately held debt and equity investments. The value of these positions tends to appreciate rapidly in bull markets as the success rate on these private investments climbs. It's important to note that BDCL features monthly leverage, which means that the 2x target multiple is applicable over the course of a single month. So BDCL won't be subject to the same "return erosion" that often hampers daily leveraged ETFs.

While the opportunity to bet big on BDCs may be appealing on its own, the real kicker to BDCL is the yield. In order to receive certain tax advantages, BDCs pay out almost all of their earnings, and that results in a relatively high yield for these securities. The leverage utilized by BDCL amplifies not only the returns, but the distributions as well. The result: BDCL has an effective distribution yield of about 15%, based on the most recent quarterly payout. That dwarfs the payouts made by junk bonds, dividend stocks and just about any other high-yielding asset class. A yield of 15% in this environment is virtually impossible to find, yet BDCL offers an opportunity to capture that return without taking on an absurd amount of volatility.

There is, of course, some pretty substantial risk that comes along with that meaty potential return. If the economy sputters, BDCL could see values decline sharply in a relatively short period. Business-development companies were among the biggest losers when stock markets cratered in 2008, and there's no reason to believe their performance would be any better in future recessions. Throw in the explicit leverage used by this product, and you've got plenty of potential volatility.

Still, the opportunity to leverage up returns, without taking on many of the risks that come along with daily reset of exposure, is incredibly appealing if you believe the overall future is relatively bright.

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