Avoid This Investment at All Costs

There are only so many times in your life that you literally fall out of your chair in reaction to the sheer lunacy of what you're reading. You're left to wonder if the words in front of you are some kind of elaborate prank from the folks at The Onion, or if the world has just gone crazy.

Today is one of those times. UBS announced it's creating an ETN, or exchange-traded note, focusing solely on recent Internet IPOs. You know, the kinds of stocks whose price-to-sales ratios are higher than most companies' price-to-earnings ratios; the ones that are wildly pushing for IPOs to cash in on a market that's suddenly become crazed for all things dot-com.

All arguments of whether these stocks are overpriced aside, the key fact that no investor can deny is that there are tremendous amounts of risks to the rash of recent IPOs. Many need transformative leaps just to justify their current valuation. Yet, UBS' ETN ... it comes with leverage.

Yes, the folks at UBS have outdone themselves and created an ETN around one of the riskiest areas of investing and doubled the risk for you. Surely we owe them some kind of gift basket for this wondrous offering to a world already in the difficult process of deleveraging and reducing risk.

Dear future, meet past
As saddened as I am by seeing this product -- a completely unnecessary means for piling on risk where it's not needed -- I'm hopeful. At the Fool, we've emphatically sided with the idea that investors can beat the market, and a large part of that is based on the irrationality seen every day. I'm talking about the short-sightedness, excessive greed, and ability to repeat past investing manias that define everyday market action. If you can look past that as an investor, you have an edge to beat the market.

So today feels a bit like a child wondering aloud if Santa Claus exists, and then having Santa Claus crash through his roof moments later. We wonder aloud if the market presents opportunities through its irrationality, and then something like UBS' leveraged Internet IPO product comes out and proves the irrational market's existence. A short decade's time ago, an Internet bubble based on the same principles formed and popped with disastrous consequences. Now that we're seeing another one form, investors have conveniently forgotten the past and are clamoring for more risk.

If you need a reminder that the markets aren't always efficient, that excessive greed is alive and well, that fact just hit you over the head today like a sledgehammer.

The bottom line
Not that this is meant to be a condemnation of all IPOs in recent years. Our Rule Breakers service has identified unique business models or other advantages in several of the companies this ETN holds, like Rackspace (NYSE: RAX  ) , Ancestry.com (Nasdaq: ACOM  ) , and OpenTable (Nasdaq: OPEN  ) .  Rule Breakers' market-smashing track record over the past seven years illustrates a history of being able to pick out seemingly overpriced businesses that keep outperforming.

The broader point is that while there will be some recent IPOs that make the jump and grow into their outsized valuations, there is also a level of hysteria around newly public Internet companies right now. If you feel the need to invest in this space, a basket ETN is an extremely risky proposition. Piling on leverage is lunacy.

If you're looking for a company riding a technology megatrend that actually produces -- watch out, this is a four-letter word for recent IPOs -- a healthy stream of profits, check out this free report compiled by the analysts of our Stock Advisor newsletter. They highlight a previous recommendation that's gone on to gain 250% since first being picked in 2009. Best of all, the company is an industry leader with proven advantages that leave it set for more gains in the future. To get the report just click here; it's free!

Eric Bleeker owns shares of no companies listed above. Motley Fool newsletter services have recommended buying shares of Ancestry.com, Rackspace Hosting, and OpenTable. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (23) | Recommend This Article (128)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 21, 2011, at 5:16 PM, Hamiltionian wrote:

    I have to wonder if this ETN was created soley for the purpose of shorting it.

  • Report this Comment On July 21, 2011, at 5:36 PM, Mikeconroy wrote:

    Profits? We don't need no stinking profits!

  • Report this Comment On July 21, 2011, at 5:56 PM, TMFRhino wrote:

    Mikeconroy,

    :)... Yeah. Who needs a p/e when we've got p/s ratios!

  • Report this Comment On July 21, 2011, at 8:14 PM, 123spot wrote:

    Beautifully written.

  • Report this Comment On July 21, 2011, at 9:07 PM, TMFRhino wrote:

    Thank you 123spot... You see something this insane.... And you can't help but take it personally; feel a need to alert others how ridiculous this is.

    Best,

    Eric

  • Report this Comment On July 21, 2011, at 11:39 PM, g89 wrote:

    Eric,

    I wouldn't argue with any of your points, but I think your analysis is incomplete without at least some speculation about UBS's motivation. First, they must think there is a market for such an ETN. Sadly, they are probably right. Second, UBS is an investment bank having an interest in high IPO prices and high stock prices of recent IPOs. They could buy a bunch of these stocks themselves to drive up the price, but doing so is very risky as you point out. Their ETN is a way to take some number of various IPO'd shares out of the float at no cost to them, and at no risk to them, which will help to drive the price of these stocks up.

    UBS is served twice. They make money from managing the ETN, and they will no doubt make money from higher IPO'd stock prices. All in all, not a bad business decision, wouldn't you say?

  • Report this Comment On July 22, 2011, at 12:21 AM, TMFRhino wrote:

    Hi g89,

    First of all, thank you for you post. Its intelligent rebuttals and questions like this that make our site such a great idea exchange for individual investors.

    I 100% agree with you. However, *MY* motivations aren't to serve the profit at UBS... My motivations are to protect the individual investor who might be fooled by such a product.

    As I said to a co-worker earlier... I don't necessarily begrudge UBS for a decision to launch such a decision.... There is probably demand for it, and that's the way of free markets. I'm not one to stand in front of the natural course of action.

    However, these markets also dictate that sites like The Motley Fool should also spring up, to find our own niche of alerting the individual investor. Its under this auspice that I must say... Please, for the love of God... If you've learned anything from us, please don't invest in this leveraged Internet ETF. :).

    Foolish best... And for continued learning and betterment of us all,

    Eric

  • Report this Comment On July 22, 2011, at 2:21 AM, rmarks1 wrote:

    Isn't UBS famous for denying Holocaust survivors their family money when they crawled out of the camps with only a carefully memorized account number. "Do you have the death certificate?" "I'm sorry but they did not give death certificates at Auschwitz". So why is anyone surprised at anything these guys do.

    Richard Marks

  • Report this Comment On July 22, 2011, at 3:38 AM, dismanirie wrote:

    Well spotted, TMFRino, and very nicely exposed for the egregiously risky investment such a product would be.

    I suppose that Richard would have found another way to link an Internet ETN to the Holocaust if it had come from Goldman Sachs...

  • Report this Comment On July 22, 2011, at 10:27 AM, gimponthego wrote:

    Good call, Eric! I would have been compelled to sound the alarm had I run across this piece of vacuous verbiage which, at the very least, draws attention to UBS in a negative manner and begs the question: who green lighted this "project" and the rational behind it?

  • Report this Comment On July 22, 2011, at 3:54 PM, Sunny7039 wrote:

    Thanks, Richard Marks, and other astute commentators. Just to add -- what's the "subtext" here? Most retail investors don't have a prayer of coming close to buying into a potentially lucrative IPO, of course.

    There are a lot of things retail investors are barred from participating in, even if they have the knowledge, and the money, and perfect credit, and no debts of any kind, and a home paid-in-full, and a multi-year cash/cash equivalent cushion.

    Trust me on this one. I know.

    Uh . . . and this is fair, how, exactly? Ah. Not at all, you're thinking?

    Right. That's what I was thinking, too.

    (BTW, I heard an ad on the radio the other day telling people that by selling covered calls, they would be "taking control" of their stock portfolios. I'm not kidding. I wish I were.)

  • Report this Comment On July 22, 2011, at 4:01 PM, g89 wrote:

    Hi Eric,

    Thanks for the response. My points about UBS's motivation supports your observation that this is something investors should avoid. I very much appreciate your motivation to point out the risks and perils associated with this product.

    On a related note, I believe everyone would be better served (unfortunately) by new SEC regulations prohibiting large financial firms from recommending certain products to investors in which they, the financial firm, has a large stake and conflict of interest.

  • Report this Comment On July 29, 2011, at 11:51 AM, LorynToo wrote:

    Sounds like a very foolish investment. I don't always agree with the Motley Fool, but this time they are definitely right. I'll stick with my food related investment strategy. Looked at gold, but its got far too far to fall.

  • Report this Comment On July 29, 2011, at 12:18 PM, AWebbInWV wrote:

    Looks like A GREAT INVESTMENT to sit and wait til they run it up and then SHORT THE HECK OUT OF IT.........

  • Report this Comment On July 29, 2011, at 12:47 PM, johnburton2003 wrote:

    Former Senator Phil Gramm is employed by UBS AG as a Vice Chairman of the Investment Bank division. That is reason enough to run away.

  • Report this Comment On July 29, 2011, at 12:58 PM, tweetybirdvicky wrote:

    Avoid it?????????????????? This is one product they probably are putting out to the public lemmings so they can SHORT IT!!!!!!!!!!! They do it all the time!

  • Report this Comment On July 29, 2011, at 1:08 PM, jackyboy42 wrote:

    Hi Eric,

    Thanks for sharing your opinion. However I would like to point out the other side of this argument. First, the market is in a transitional period of deleveraging, as you mentioned at the beginning. The risk level on most portfolios has come down substantially, and many people are hard pressed to look for a low cost growth prospective. This fund, although high risk, does offer a cheap growth alternative to those who have already deleveraged. In the short term, a lot of the high-growth oriented companies are in this sector. As far as the high P/E multiples, that does not necessarily hamper the growth of a stock just look at Amazon it has a P/E of 96. That being said, the growth rates for most of those companies are unsustainable and pose a substantial risk to the long-term health of any portfolio. However it may provide a shorter term investment in a growth sector for those who can tolerate the risk.

  • Report this Comment On July 29, 2011, at 1:26 PM, rmarks1 wrote:

    Ah yes, the wonderful UBS (Union Bank of Switzerland) who denied my ancestor holocaust survivors their deposits. They carefully memorized Swiss account numbers and after they were freed from the concentration camps went to UBS to claim their money to no avail. "May we see the death certificate", "I'm sorry they don't give death certificates in Auschwitz".

    May UBS rot.

  • Report this Comment On July 29, 2011, at 1:36 PM, misquamicut wrote:

    I had my accounts at UBS once. I finally figured out UBS stands for "you've been screwed".

    re the Holocaust, isn't UBS an 'old and venerable institution'? Sorta like Goldman Sachs?

  • Report this Comment On July 29, 2011, at 2:03 PM, delange001 wrote:

    If I understand correctly, the ETN, even though referring to IPO's is actually based on UBS's performance in future.

  • Report this Comment On July 29, 2011, at 2:13 PM, Counterguy wrote:

    All these arguments are valid. This just sounds like buying into bundled mortgages that are basically grouped subprime mortgages that banks did not want to hold. And then have a company like AIG guarantee that a subprime mortgage wouldn't fail by selling insurance to cover that risk. Has the world gone mad?

  • Report this Comment On July 29, 2011, at 3:03 PM, deckdawg wrote:

    It would be helpful to explain how the product works. It's an ETN related to IPOs and it's leveraged. I know what an ETN is, what an IPO is and what leverage is ... but how is all that put together in this product? Usually an ETN is pegged to some sort of index ... what are the details?

  • Report this Comment On July 29, 2011, at 7:51 PM, Marlok wrote:

    The odds favor the house.

    Its a casino format.

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