New Fund Goes for Yield in a Big Way

NEW YORK (TheStreet) -- Recently we looked at multi-asset class funds and whether they could serve as a one-holding portfolio. The latest fund to join the discussion is the ETRACS Diversified High Income ETN (DVHI). The new fund seeks to offer a 60% equities/40% fixed-income target allocation, a common mix for individual investors.

The equity portion is comprised of business development companies (15%); master-limited partnerships (15%); and mortgage real estate investment trusts, non-mortgage REITs, U.S. equities and foreign equities (all 7.5%).

The fixed-income portion puts an equal 10% into preferred stocks, emerging-market bonds, municipal bonds and high-yield bonds.

ETRACS reports the yield of the underlying index to be 7.71%, which after accounting for the 0.84% "annual tracking rate" could put the fund's yield at 6.87%. DVHI will pay monthly, but the rate paid could vary. It is important to remember that with all exchange-traded products, any future yield could be more or less than what is now indicated.

The individual holdings in DVHI are a combination of individual issues and exchange-traded funds. Two of the segments owned by the fund are captured with just one ETF. The PowerShares Emerging Markets Sovereign Debt Portfolio ( PCY) is the sole holding for emerging-market debt. For high-yield debt, DVHI goes with iShares iBoxx High Yield Corporate Bond ETF ( HYG).

The two largest individual holdings in the fund are Ares Capital ( ARCC), a business development company, and Energy Transfer Partners ( ETP), an MLP.

The composition of the fund should make it clear that the two priorities under the hood are diversification and yield. That should appeal to many investors. The fund, however, is exposed to a lot of interest rate risk.

Earlier this week, markets were granted a reprieve when the Federal Reserve's Open Markets Committee announced that it wouldn't begin to reduce its bond-buying program.

In late May, the committee indicated that it could reduce purchases later in the year, and as the story developed, markets participants came to believe that September was the month that a change in policy would be announced. So we know that purchases will continue as is for now, and we also know that at some point, the Fed will reduce its monthly purchases. What we don't know is when.

Late May and June gave a hint of what certain market segments might do when the so-called tapering begins. Some of the hardest hit areas are featured prominently in DVHI. For the month ended June 22, PCY declined by 14%, HYG by 7%, ARCC 10% and ETP declined by 9.5%, and keep in mind the Fed didn't actually do anything.

The Market Vectors High Yield Municipal Index ETF ( HYD), one of the funds used in DVHI for muni bonds, went down 14% in that same month. Whenever the Fed does start to taper and then whenever interest rates do start to go higher, DVHI is likely to get crushed because so many of the areas it owns are sensitive to interest rates.

The idea of one fund making an entire portfolio is appealing, but if the 30-year bull market for bonds is ending, then investors will want to take a more tactical approach and probably want to avoid many of the areas owned in DVHI.

One final note is that DVHI is an exchange-traded note, not an exchange-traded fund. That means it is an unsecured debt obligation of the issuer, which in this case is UBS. As an ETN it won't actually own anything, it will simply track the index described above. If UBS were to go bankrupt, a very low probability, note-holders could be completely wiped out.

At the time of publication, Nussbaum held no positions in any of the stocks mentioned, athough many of his firm's clients own PCY.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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