UBS' new E-Tracs linked to Wells Fargo Business Development Company index bring new strategy

By Emma Trincal

New York, April 28 - UBS AG, Jersey Branch priced exchange-traded notes that give investors exposure to venture capital via business development companies for the first time. They began trading on Thursday on NYSE Arca under the symbol "BDCS."

UBS priced $10 million of exchange-traded access securities due April 26, 2041 linked to the Wells Fargo Business Development Company index, according to a 424B2 filing with the Securities and Exchange Commission.

Earlier this month, the bank said it planned to sell up to $100 million of the securities.

The remaining $90 million will be sold from time to time at varying prices.

Pioneer product

"This is the first exchange-traded note in the market that is focused solely on business development companies. Investors in this new ETN will gain direct, convenient access to a diversified index of BDCs," Christopher Yeagley, managing director and U.S. head of equity structured products at UBS, said in a company press release

Business development companies are publicly traded venture capital funds that invest in start-ups, in particular through mezzanine financing. As such, they give investors access to a private equity strategy.

Unlike private equity funds, though, business development companies are open to non-accredited investors.

"The general concept is to gain access to private equity for the common investor," said Steve Doucette, financial adviser at Proctor Financial.

"With an ETN, you're getting private equity exposure in a liquid format."

The benefits of investing in an ETN linked to an index of business development companies is two-fold, according to the preliminary prospectus filed April 1: yield and diversification.

Yield

The E-Tracs provide income potential via variable quarterly coupons. The quarterly coupon is the sum of the cash distributions that a hypothetical holder of the index constituents would have received during the quarter minus an accrued tracking fee of 0.85% per year.

The Wells Fargo Business Development Company index has 26 constituents, which are all business development companies listed on the New York Stock Exchange or Nasdaq and that satisfy specified market capitalization and other eligibility requirements.

"They were created to channel capital to small businesses, and for this reason Congress exempted them from corporate taxes. Therefore they have a lower cost of capital," said a market participant who follows the business development company market.

The lower cost of capital can in turn be passed on to investors, he said. As a result, business development companies are appropriate investments for yield-seekers, he added.

"For the investor, the advantage of investing in BDCs is yield," he said, adding that business development companies are supposed to distribute 90% of their net cash flow to investors. The distribution is net of the management fees investors pay the company.

According to the 424B2 filing filed Thursday, the Wells Fargo Business Development index's estimated annualized return was 7.92% from Sept. 30, 2004 through April 25 versus 4.91% during the same period for the S&P 500.

"It's a pretty good performance given that you had a rocky market in 2008," said Doucette.

"But you'd have to do the due diligence. Are you being rewarded for the risk? It really boils down to what the underlying companies are and how much you get compensated for the risk."

Doucette said that he was uncertain about the risk/reward profile of the ETN.

"Looks like it's for income. But I'm not investing in private equity for income. If I'm going to take the risk of this asset class, I want growth; I want private ownership and equity appreciation," he said.

Diversification

The second benefit of the notes, according to the initial prospectus, is that it "gives investors exposure to a portfolio of BDCs in a single investment."

But the market participant said that the extra cost and the credit risk incurred by the investor in the notes may not be worth it given the small universe tracked by the index.

"I'm not sure why it would make sense to buy an ETN instead of investing in the BDCs directly," he said.

"The BDC universe is quite limited; you have two dozen of them. It's not like you have hundreds of them."

Being first

This product is the first of its kind, according to UBS and to sources, and some predict that others will soon imitate the idea. Doucette said that he would probably look at the product, but not before other firms roll out their own version of the concept.

"It's the first ETN out there. At some point, you'll see the copycats, five other products coming out with something similar. It's best to make an investment decision when you have the choice between different vehicles," he said.

The payout at maturity will be par of $25 plus the index return, which could be positive or negative, plus the final coupon amount minus the accrued tracking fee.

The notes are putable, subject to a minimum of 50,000 and a redemption fee of 0.125%. They are callable beginning April 30, 2012.

UBS Investment Bank is the agent.

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