Eaton Vance's eUNITs trust tied to S&P 500 breaks new ground, says Eaton Vance's CEO

By Emma Trincal

New York, Jan. 30 - With the launch of its eUnits 2 Year U.S. Market Participation Trust: Upside to Cap/Buffered Downside, which priced $26.18 million in an initial public offering, Eaton Vance Corp. is providing retail investors with the benefits of structured investments in a more liquid, less risky closed-end fund format.

"We think it is groundbreaking," said Thomas E. Faust Jr., chairman and chief executive of Eaton Vance, in a Prospect News interview.

"It fits into the broad definition of a structured product. It's certainly not a note. We call it 'trust,' but it's a regulated fund.

"For us, it's a way to fulfill some similar investment needs that investments in a structured note are designed to accomplish while avoiding the concentrated credit risk exposure. It also enables us to offer transparency and arm's-length pricing on the underlying structural features that provide here the upside and the downside protection."

The new type of exchange-traded structured investment mimics the benefits of structured products by enabling holders to participate in the returns of a specified market benchmark over a defined term, typically up to a cap, while reducing exposure to loss in the event of a decline in the benchmark, according to a news release from Eaton Vance.

The new issue is linked to the performance of the S&P 500 Composite Stock Price index.

The trust seeks to provide a return equal to any percentage increase in the index, subject to a cap of 17.85%. Unitholders will receive only the initial net asset value of the units if the index declines by 15% or less and will lose 1% for every 1% that the index declines beyond 15%.

No concentrated credit risk

Faust said the trust offers several advantages over a traditional structured note. The first one, he noted, is to relieve investors from the concentrated credit risk exposure that is the hallmark of structured notes.

"The consistent objection to structured notes on the part of advisers and investors is the concentrated credit risk. Our new fund is a response to this," he said.

"It's a more protective way for the investor to get a hedged exposure to the equity markets.

"We did it through a fund structure - a closed-end fund - where we invest in a portfolio of Treasuries and enter derivatives contracts with three third-party dealers.

"So unlike a note, you no longer have a concentrated credit exposure to a single corporate issuer; instead you have diversification of the counterparty risk between three different dealers," he said.

Nascent trend

Eaton Vance is not the first manager that introduced a 1940 Investment Act product offering some of the features of a structured note.

In 2011, Advisors Asset Management launched its multi Enhanced Return Investment Trust, High 50 October 2011 Series, which provided exposure to a multiple of the total return of the stocks selected using the High 50 Dividend Strategy. The format used for the Advisors Asset Management investment was a Unit Investment Trust, not a closed-end fund. But the principle is similar, said Carl Kunhardt, wealth manager at Quest Capital Management.

"There are two major investing innovation trends going on right now - actively managed ETFs and non-traditional assets and strategies delivered in a 1940 Act different wrapper," he said.

"You're going to see more and more of both."

Limited counterparty risk

Risk is not only reduced by diversifying the counterparty exposure across three different parties, said Eaton Vance's Faust.

In addition, counterparty risk is limited to the in-the-money value of the derivatives contract positions.

"It's a structured product in the sense that it hands a payout profile that derives from the market performance and it has embedded optionality similar to a structured note.

"It's not a note issued off an issuer. It's a closed-end fund that holds a portfolio of Treasuries and provides market exposure through a portfolio of derivatives contracts to mirror the terms that the fund itself is seeking to provide," he said.

The trust will purchase Treasuries and futures contracts on the index with tenors that are the same as the expected investment life of the trust. The contracts will be structured so that the trust will receive cash from the counterparties if the index increases over the term of the contracts.

"We only have counterparty exposure to the extent that the fund is in the money," said Faust.

"If the fund goes up, the counterparty will have to pay us. They provide the upside.

"If the fund is down, we owe the counterparty money. But we have the collateral posted every day to mitigate that risk," he explained.

Waiting for better upside

Giving enough upside to investors was an important consideration for Eaton Vance, Faust said.

The trust first announced plans to issue units on Sept. 20, 2010. At the time, it was called the eUNITs 2 Year U.S. Equity Market Participation Trust: Enhanced Upside to Cap/Buffered Downside.

Last week's IPO was the first time the concept was finally implemented.

"We were planning to come to market in 2011," Faust said. "But volatility levels in the first half of last year were so low we were not able to provide an attractive enough upside."

He said, "We would have had an upside of less than 15%. We considered that, at least for an initial offering, we should have pretty much the same amount of buffer and upside potential.

"So the delay was related to the market environment, not that there was no demand," he added.

Transparency for arbitrage

Another potential advantage over structured notes is transparency, Faust said.

"When the structure is put together we go out to the market and enter derivative positions. Our negotiated positions are disclosed to the investors. It makes this investment more transparent than a structured note."

"The premise is to provide efficient secondary market trading," Faust said.

The eUnits, unlike most closed-end funds that have a perpetual life, have a termination date, he said.

The trust plans to conclude its investment activities on Jan. 24, 2014, at which time it will distribute its net assets to the unitholders.

"Having a fixed-term, a fixed portfolio and being very transparent make the product very appealing to arbitrageurs who can buy at a discount and hold to maturity in order to get the full value of their investment," he said.

Just a beginning

Faust said that this structure could apply to other market benchmarks or other lengths of time.

"We have no specific plans for a follow-up launch with a specific structure. We expect to do some more however. But we haven't filed anything yet," he said.

"It will depend on market conditions and our ability to put together a selling group.

"One option may be to do the same type of product, using the same benchmark but on a different timeframe.

"Other types of benchmarks that we may consider would be U.S. stocks, international stocks, commodities, currency and potentially fixed-income instruments," he said.

Fee-based friendly

Finally, the notes offer an advantage for fee-based planners or advisers, he said.

"We offer a different offer price if you are a fee-based account," he said. "And we see a significant movement toward fee-based accounts."

The 2,618,389 units have an initial net asset value of $10.00 each. The price to the public is $10.00 for units placed to fee accounts and $10.20 for units placed to non-fee accounts, according to a 497 filing with the Securities and Exchange Commission.

"The adviser can be compensated by an upfront fee or sales load of $0.20 per $10.20 unit if the client account is a broker-dealer type," he said.

"In other cases, if it's a fee-only account, a no-load makes sense," Faust said.

"The offering price can vary based on the type of relationship with the client," he added.

Innovation with these new types of structured investments created in a 1940 Investment Act format may have a big impact on the traditional structured note market, some predict.

"It's a small offering for us but it's important for the development of a new type of structured investments," said Faust.

"I wouldn't be so bold as to predict the end of structured notes. But this new type of investment will add significant competition to existing products. It will not be a replacement for structured notes, but rather a complement similarly to exchange-traded notes," he said.

The units began trading Friday on NYSE Amex under the symbol "ETUA."

Eaton Vance Management is the trust's investment adviser and administrator.

Parametric Risk Advisors, LLC is the subadviser responsible for providing advice on and execution of the contracts.

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