How about a no-brainer—40% in 2019 IF you act by end of tomorrow

Dear Subscriber, 

Action to Take: 2X weight in SMHB—Buy Under $23 with $26 Target and 24% Yield in 2019. SMHB should go ex-dividend on January 12, 2019 with the Special dividend of @50 cents to be paid 12 days later on January 24, 2019. First Quarter Yield will be @$2000 on a $20k position!

Alert: This goes Ex-Dividend January 12 so you must get shares by end of tomorrow to get the special dividend.

Summary

How about the 15-20% bounce in our “Double Down on MORL MRRL NRX BDCL MI” advice in December newsletter Part 1! The Dec/Jan Flash Crash over the last week has produced more great high-yield opportunities. SMHB, a leveraged ETN based on a high-dividend small-cap index is one such opportunity that is TOO good to pass up! The low trading volume small-cap stocks in various indexes got CRUSHED in the Flash Crash = opportunity!  

SMHB is an index of small-cap dividend payors currently yields @ 24%, and provides exposure to a highly diversified portfolio.

This is another ETRACS Monthly Pay 2xLeveraged US Small Cap High Dividend ETN Series B SMHB.
The recent price drop has made SMHB even more attractive. SMHB's Current Yield (annualized) is @ 24%, which is calculated as “the sum of the most recently announced Coupon Amount and the two immediately preceding Coupon Amounts, multiplied by four (to annualize such coupons), divided by the Current Indicative Value of the ETN”.

About SMHB
SMHB is a diversified exchange product issued by UBS Bank that tracks (twice leveraged) a basket of small cap high-dividend stocks. Same ETN (exchange-traded note) as our MORL MRRL BDCL positions.  This note provides instant diversification in several sectors across the small cap, high- yield spectrum which got CRUSHED from panic index selling in the  Algo/Risk Parity Flash Crash. 

SMHB is a new ETN issued just a few weeks ago (at the beginning of November) but the concept is not new. This is the sister Fund of ETRACS Monthly Pay 2xLeveraged US Small Cap High Dividend ETN Series A (SMHD). Both funds are issued by UBS Bank (UBS) like MORL MRRL BDCL and track exactly the same index and are also 2 times leveraged. In fact, SBHB and SMHD are almost identical with very minor differences.

Why did UBS Bank issue the SMHB Product?
Most of the UBS Products have limits on how many notes (shares) they can issue.  This is why our MORL is not issuing new shares and MRRL is the new version (and better buy since it trades at net asset value (NAV) v.s MORL at a slight premium. You can view these limits by clicking on the UBS ETRACS website, and then go to the press release section. The limits are listed on the press release dated October 8, 2015. If you wish to check the press release page, click here. The maximum number of notes that SMHD can issue is 4 million notes, and UBS Bank is very close to reaching this limit. Therefore, UBS is not allowed to issue more SMHD shares, and created SMHB to fill this void. So SMHB can be viewed as a continuation of the SMHD issue, and they both provide the exact same exposure. 

How to Calculate the Yield for SHMB?
SMHB is a new product and since the issuing bank uses historical dividends to calculate the yield, currently no yield is showing for SMHB. But the good news is that we can deduce its dividends from its sister fund SMHD.
ETNs such as SMHB and SMHD will normally trade at very close to their Indicative Value which is the case right now with SMHB. But since SMHD cannot create any new shares, it has been trading at a premium of around 10%. SMHB was issued at a significantly higher price than SMHD, and perhaps the dissimilar pricing of the two issues is contributing to some buyers not recognizing that SMHB is currently the more advantageous issue.

SMHD has an annualized payout of $3.1948 (using the last 3 months coupons). The relative Indicative Value of the pair gives us a constant ratio of 1.53 which can be used to deduce an annual distribution of $4.888 for SMHB, and it comes to @24% yield under $22.50 buy under. Add in price rise to $25 ish and we have locked in 40%+ return in 2019.

PS—IF you don’t need the income, reinvest the dividend under $25!

The High-Dividend Opportunity-“Dislocation”
Small cap stocks are the first ones to decline when the markets go into panic selling mode but they are usually the first ones to recover when the markets start going up, and they do recover quickly! Low volume trading and index inclusion make them take a big hit with valuation and dividends suddenly invisible to the index redemptions.

SMHD and SHMB are the only two funds that track the Solactive U.S. Small Cap High Dividend Index (the "Solactive Index") which is a fairly diverse index of small cap stocks that pay a high dividend.
Since SMHB is new and nearly identical to SMHD, let’s look at the distributions paid over the last few years.

This yield certainly qualifies as "variable" on a monthly basis, but if you look on a yearly basis, the dividend is more predictable and not as variable. Part of the variability from month-to-month is because both funds only pay out the dividends as they are received from the underlying stocks.

Key point: This ETN structure is actually a big advantage because there is never any "Return of Capital"(or ROC) which is associated with many funds and which can be destructive to holders. In short: SMHB and SMHD never overpay shareholders from gains that have not been realized.

On November 9 when SMHB was issued, it was trading at $24.90.

Strength through Diversity
Diversification is a very important tool for managing risk. This is true for any portfolio and especially when investing in small-cap stocks. By investing in SMHB for instance, you get instant diversification in 100 different stocks and in multiple sectors and industries. Holding 100 companies insulates the fund to some extent from any single (or even several) companies having a big drop in share price or even in case of a dividend cut by one of the underlying stocks.

The portfolio held by the fund are on the UBS  website  Over 30% of SMHB’s holdings are invested in Property REITs as seen in the table below. These small REITs got crushed on the Fed Rate hikes—now that the Fed has 

Figure 1 Source

With some 30 different REITs, which have tenants in many different industries, we are satisfied with the diversity here. NO Sears’s stores! The average position size for each Property REIT allocation is just about 1%.
Mortgage REITs make up just shy of 25% of the portfolio as seen in the table below.
Action to Take: We obviously have a lot of Mortgage REIT exposure—if you are too heavy in allocation use some MORL/MRRL profits from our “Double Down” in late December to fund this

 Source

The average allocation to each of the 22 mortgage REITs is 1.11%.
Business Development companies make up just under 8% of the portfolio as seen in the table below. We own NEWT and BDCL in this space.
Source

SMHB has also exposure to the financial sector in forms other than BDCs or REITs. Here is the list.
 Source

The average position size in BDC's here is 0.67% of the portfolio, or 4.69% in total for the 7 companies.
Below is a list of the remaining 19 companies that fill out the portfolio. These include a newspaper chain (owner of USA Today), a gaming company, and the company that makes Tupperware (TUP), among others. These further help increase the diversity of the fund.
Figure 5 Source

How Safe is SMHB's Dividend?
The dividend reflects the dividends of the underlying 100 stocks (times 2). Even if a couple of the underlying stocks reduce the dividends, it will not have any material impact on the dividend of SMHB. Due to the diversity of the dividend source, SMHB's dividend has a pretty high margin of safety. Note that quite a few of SMHB's holdings have increased their dividends including MAIN, APTS and SKT.

Risks

• As with all leveraged funds, volatility is a risk. Do not buy this unless you are prepared to handle some fairly big price swings. 

• Key Point: IF YOU DON”T NEED the income, reinvest these dividends up to $25. Reinvesting our BDCL MORL MRRL MI and NRZ dividends plus appreciation has almost doubled our yields and value of these positions since we started them years ago.

• Do NOT invest in SMHB if you do not plan to buy and hold for several years. Because it is very volatile, SMHB like any of these 2X ETN’s can underperform in the very short term, but can still provide great returns if held over a long period.

Big Dividend Coming Soon!
One thing to note is that the distribution seems to be a lot higher in the first month of the quarter than it is in the last 2 quarters, so we would expect the distribution for January to be in the neighborhood of 45-50 cents if we base our estimate on the distribution history of SMHD. If a 50 cents distribution is paid for SMHD, that would be equivalent to a 76.5 cent for SMHB. This is a big payout of 2.6% yield paid in a single month! You can see the distribution history for SMHD here. For the short distribution history of SMHB use this link.

Key Point: SMHB should go ex-dividend on January 12, 2019 with the dividend to be paid 12 days later on January 24, 2019.

Final Thought: With our Double Down on MORL MRRL NRZ BDCL MI we are up almost 18% in NAV value and have locked in 22%+ yields!  That is 40%+ annual return JUST from being patient and waiting for these dislocations. These are the opportunities in panic selling markets that are amazing and VERY low risk with the Fed now on hold till June at least. IF we are dead wrong and the Fed raises Jan 30 (2% chance in the futures market today) these securities will get hit a bit. BUT who cares?

More opportunities to come ASAP. So far we are 1-for-1 on our 2019 thesis--the Fed/Powel FOMC IS doing a moonwalk backward on their hawkish behavior. Now we need POTUS Trump to choose to not commit political suicide and tell his negotiators in China that 1) MAKE a Deal on the easy stuff and 2) Do NOT require the complete reconstruction of the Chinese economy but give us a timetable and observation capability to "trust but verify" aka the Regan Doctrine. 

God, I love the smell of panic selling in the moring and psychoanalyzing the survival instincts of people in power!

Toby