The Royal Bank of Scotland last week (10/24/11) launched an exchange-traded note (“ETN”) linked to the performance of the NYSE Arca Equal Weighted Pharmaceutical Total Return Index. There are already four exchange-traded funds (“ETFs”) tracking this industry. Why anyone would want to gain exposure to drug companies via uncollateralized debt securities is not clear, leading me to believe that this product will likely fail.

RBS Global Big Pharma ETN (DRGS) will track, less an investor fee 0.60%, an underlying index that holds stocks and depositary receipts of 16 large cap global (50% are US based) pharmaceutical companies involved in various phases of the development, production, and marketing of pharmaceuticals. However, DRGS is an unsecured debt obligation issued by the Royal Bank of Scotland and does not hold any of the 16 stocks in the index.

The index currently has a 3.3% yield, but DRGS does not plan on making any distributions to reflect that yield. Instead, it tracks a “total return” index with the ETN’s net asset value reflecting the reinvestment of dividends.

The four ETFs that DRGS will compete with:

  1. SPDR S&P Pharmaceuticals (XPH) (XPH overview) has an expense ratio of 0.35% and currently holds 29 US pharmaceutical stocks using a modified multi-tier equal-weight methodology.
  2. iShares DJ US Pharmaceuticals (IHE) (IHE overview) has an expense ratio of 0.47% and currently holds 39 US pharmaceutical stocks using a capitalization weighted methodology.
  3. PowerShares Dynamic Pharmaceuticals (PJP) (PJP overview) has an expense ratio of 0.63% and currently holds 30 US pharmaceutical stocks using a quantitative selection process and a multi-tier equal-weighting methodology.
  4. HOLDRS Pharmaceutical (PPH) (PPH conversion to Van Eck ETF) has annual expenses of only 8 cents per share in the HOLDRS structure. It is slated for transformation into the Market Vectors Pharmaceutical ETF (PPH) later this year, holding 25 global pharma stocks (including all 16 in the underlying index for DRGS) with an expense ratio of 0.35%.

DRGS is the first ETN offering from RBS that is not part of its TrendPilot family of asset class timing ETNs. Its global focus and equal weighting are the only attributes that can potentially be considered positive features. However, those are probably not enough to overcome the higher expenses and ETN structure. Additional information is located in the overview and fact sheet (pdf).

Disclosure covering writer, editor, and publisher: No positions in any of the securities mentioned. No positions in any of the companies or ETF sponsors mentioned. No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.