Business Development ETNs?

That's because the exchange-traded product industry suddenly seems to be quite focused on "business development companies." So-called BDCs specialize in making loans to smaller companies-the very ones that are still having a hard time getting them three years after the credit markets completely broke down and the stock market crashed.

Last month, UBS rolled out the UBS AG Exchange Traded Access Securities (E-Tracs) Linked to the Wells Fargo Business Company Index (NYSEArca:BDCS) and then followed it up this week with the launch of a double-exposure version of the first one, which it called the very fetching UBS 2X Leveraged Long Wells Fargo Business Development Company ETN (NYSEArca:BDCL).

As an aside, these names are seriously the stuff of ETP-industry stand-up comedy. I'm told their complexity is linked to requirements of the 1933 Securities Act, under which ETNs are registered. But will someone please tell the lawyers drafting these prospectuses to take a chill pill? I can see old brokers falling asleep during free lunches-courtesy of ETN sponsors-just 50 syllables into the name of what might actually be a worthy ETN.

But I digress. What's caught my attention is that UBS went live last month with the first of its two ETNs a day before Van Eck put an ETF into registration targeting both BDCs and specialty finance companies, the latter being providers of targeted, often project-specific credit to entrepreneurial companies.

Then, barely a week later, Van Eck put a separate ETF into registration that targets only BDCs. Van Eck, in the quiet period of fund registration, couldn't explain why it would be simultaneously pushing to market two ETFs that look so similar.

Clearly, something is going on.

But, to be fair, neither UBS nor Van Eck is the first to bring a BDC ETF to market. That honor goes to the PowerShares Global Listed Private Equity Portfolio (NYSEArca:PSP), which allocates about 20 percent of its portfolio to BDCs. It went live in October 2006, and now has assets of about $470 million.

A New Type Of Creditor

The way people at UBS describe it is that BDCs are poised to fill a void that has yet to be filled since the collapse of two Bear Stearns mortgage-related hedge funds in June 2007 ushered in a "credit crunch" that morphed into a full-fledged freeze with the collapse of Lehman Brothers in September 2008.

You read a lot about big companies now having no problem getting credit if they need it. But, they've focused intensively on building up their balance sheets since the market crashed, so even if they can get credit, a lot of them don't really need it.

But regional banks-the ones that have historically provided credit to small and midsize businesses, haven't really fired up their lending to the companies that most need of it.

It would be a welcome thing if BDCs were filling that void.

It's been four years since the economy started becoming unhinged, and because smaller businesses are the biggest engine for job growth, BDCs making loans to them might really mean the economy can start growing without all the government help it's been getting.


The other interesting aspect of this recent focus on BDCs is how it pits the ETFs against ETNs.

The catch with the ETF wrapper and-with funds like PowerShares' PSP-is that under the Investment Company Act of 1940 that governs most ETFs, a fund can't own more than 3 percent of any one BDC.

This could make it hard for the ETF manager to make sure the fund is tracking its underlying index. You could also imagine an ETF that basically can't create new shares because of this limit, turning it into something like a closed-end fund trading at a discount or premium to its net asset value.

But ETNs don't have that limitation and, as UBS showed this week, they are the perfect vehicles with which to serve up leveraged exposure. That means the ETN that UBS served up last month with what it said was a 7.5 percent annual distribution now comes in a different package that yields 15 percent.

Too good to be true? Maybe.

The catch is that an ETN is an ETN, which is to say it's only as reliable as its issuer. Should the issuer become insolvent, ETN investors would be left holding the bag. I've spoken to a fair amount of advisors who avoid ETNs on principle for this very reason, even if it's a long shot.

That's hardly an abstraction for UBS, which received more than $5 billion in bailout money from the Swiss government in 2008 and was allowed to transfer up to $60 billion in distressed assets to a fund supported by Switzerland's central bank.

Better yet, on the very day UBS rolled out its BDCL, its double-exposure BDC ETN, the Wall Street Journal ran a front-page story that UBS was looking to separate its investment banking arm from the rest of its operations to satisfy Swiss regulators hedging their bets should UBS find itself in dire straits again.

At the very least, investors will have choices should they choose to invest in BDCs. And that, in my view, speaks to the dynamism of the world of exchange-traded products.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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