EFO ProShares Ultra MSCI EAFE

The ETF industry has been booming over the past few years. Now, there are close to 1,500 exchange-traded products in the market place with 50 sponsors and over a trillion dollars in AUM.

Total fund launches have already breached the 100 product barrier for 2012 while assets have increased by almost $100 billion in the same time frame.  New products are now in almost every conceivable industry, giving investors exposure to a number of market segments including ‘crossover bonds’, cloud computing, and small cap Singaporean stocks.

While many of these products have been welcomed additions to the market, there are several that have failed to catch on with investors or are just downright strange. Sometimes, fund issuers stretch too far in their efforts to capture assets and we are left with the results of poorly thought out products that are unable to gain any level of traction in the market (see ETFs vs. ETNs: What’s The Difference?).

One such example of this phenomenon is arguably with the case of the iPath Long Enhanced MSCI EAFE Index ETN (MFLA), a note that is arguably one of the worst in the American market at this time. While this might seem like a bold claim at first glance, the product certainly has a host of issues that have kept investors away so far, and look to repel ones in the future as well.

Below, we discuss the reasons for why this iPath note should be avoided and how it has become one of the most undesirable products in the broad ETP market today:

This product offers a leveraged return on the performance of the MSCI EAFE Net Total Return Index which is a free float-adjusted market capitalization benchmark that seeks to provide exposure to over 20 developed markets from around the globe. While this may sound promising, and even very useful to a number of traders and hedgers, the actual execution has made the note more or less untradeable for many investors.

Structure

First, investors should note that the product is structured as an ETN instead of an ETF. This means that the product faces credit risk from the underlying issuer, Barclays. This implies that if Barclays goes belly-up investors may not receive their full capital back on their investment, although this possibility is relatively remote.

Still, it is a risk nonetheless, and it is one that investors who purchase ETFs do not have to deal with at all. Furthermore, since it is a debt security, the MFLA does expire—11/30/2020—so some investors may be put off by this issue as well (read ETF Investors: Beware The Coming ETN Backlash).

Leverage Rate

Beyond this problem, which is relatively minor, there is also the issue of the ETN’s participation rate. According to the iPath website, the current participation rate for MFLA is roughly 2.2.

This means that the note, for investors who buy in now, are not getting a 2x leverage rate but instead are getting a 2.2x rate of leverage. This is because, unlike most leveraged ETPs, MFLA does not ever rebalance, a situation that can allow divergences from the 2.0 leverage rate to develop over time.

While this isn’t necessarily a problem, it is something that many investors are probably not aware of at this time. Instead, it is likely something that investors have figured out when trying to match up returns for this note to the underlying unleveraged index for any long performance period.

Furthermore, it is also a problem that makes it very difficult to compare this note to others in the same space that use either a daily or monthly rebalancing scheme, making MFLA the odd man out from that perspective as well.

Expenses

If that weren’t enough of a problem, there is also the issue of expenses. Currently, the product charges a yearly fee of 80 basis points a year. While this is somewhat high compared to unleveraged products, it is actually lower than what many investors see in some of the leveraged products that are comparable to this iPath note.

However, this isn’t the end of the expenses for MFLA as there is also a ‘financing rate’ charge that investors should be aware of. This charge currently equals the three month LIBOR plus sixty basis points, a figure that is currently at 07 basis points a year (read The Guide to the 25 Cheapest ETFs).

When adding this extra 47 basis points onto the total, MFLA doesn’t exactly look like a bargain anymore, instead pushing the cost up to the 1.87% mark (assuming current LIBOR rates hold).  

Volume

The last major problem for the note comes in the volume department. The product sees a paltry average volume that is below 1,000 shares a day and it actually hasn’t traded since January (as of 6/22/12)!

While funds and notes with low levels of volume tend to get a bad reputation, this is one case where the poor repute is deserved. The bid ask spread is absolutely enormous coming in at roughly 52% according to XTF.com (also read Use Caution When Trading These Three Illiquid ETFs).

As an example, the product is currently at $92.77 per share but sees a bid of 42.61 and an ask of 128.63, making it pretty much impossible to trade, and premium/discount issues a near every day occurrence.

Better Alternatives

Clearly, MFLA has a host of problems and that is probably why it has less than $3 million in AUM. Fortunately, however, there are a number of alternatives that could make for better choices in the space including the Direxion Daily Developed Markets Bull 3x Shares (DZK) and the ProShares Ultra MSCI EAFE Index Fund (EFO).

These two funds have some stark contrasts to their iPath counterpart which could make them better ways to play the EAFE region in leveraged form. First, both products are ETFs which means that they don’t have credit risk, while they utilize a daily rebalancing program, which should help to keep participation rates in line over time.

Furthermore, while these products don’t exactly have the most robust levels of volume either, they actually do trade on a regular basis unlike MFLA. This helps these funds to keep bid ask spreads comparatively low and thus tradable within a reasonable range (see Five Cheaper ETFs You Probably Overlooked).

Given these solid alternatives, it is unclear why anyone would bother with MFLA when both DZK and EFO exist. Both of these choices arguably have a far better structure and could make for much more useful choices for investors seeking to make a leveraged play on the EAFE market.

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DIR-DM BULL3X (DZK): ETF Research Reports
 
PRO-ULT MSCI EA (EFO): ETF Research Reports
 
IPATH-LE ME IDX (MFLA): ETF Research Reports
 
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