Investors continue adding small-cap exposures to their portfolios ahead of potential interest rate cuts in September. Those investors looking to harness opportunities in these companies with an eye for income would do well to consider the NEOS Russell 2000 High Income ETF (IWMI).
The Russell 2000 Index is up 8.68% year-to-date as of 08/29/24, according to Y-charts data. The index appears attractively positioned ahead of interest rate cuts that may begin as early as next month. Small-cap companies often feel the squeeze of high rates more significantly than their larger peers.
With smaller funding pools, small-cap companies are often forced to use capital markets to raise money. In a rising and high-rate environment, this squeezes margins and affects profits. However, because of their elevated interest rate sensitivity, when rates begin to decline, these companies often benefit first.
Economic data continues to pave a favorable path for interest rate cuts to begin next month. Markets currently price in a 67% chance of a quarter-point cut at the September FOMC meeting. The remaining 33% of the market believes the Fed will cut rates by 0.50%, according to the CME Group FedWatch Tool.
Harness Income While Investing in Small-Caps
IWMI seeks to combine high monthly income within small caps with tax efficiency. The fund provides exposure to the Russell 2000 Index alongside an options strategy designed to generate high-income potential. The fund employs a strategy using covered calls to generate premiums.
The actively managed IWMI also uses call spreads to achieve its income goals. These spreads allow for more of the underlying to potentially participate in upside market movements when they occur compared to indexed covered call option strategies.
In addition to potential upside capture, the fund offers layers of tax efficiency for investors seeking income. The options that IWMI uses are call options on the Russell 2000 Index (RUT) and qualify as Section 1256 contracts. These receive favorable tax treatment under IRS rules. The options held at year’s end are treated as if sold at fair market value on the last market day. Any capital gains or losses are taxed at 60% long-term and 40% short-term, no matter how long they were held.
NEOS also actively manages the call options to capture gains in the underlying assets or minimize losses. In addition, the fund’s managers also engage in tax-loss harvesting opportunities throughout the year on the call options, equity holdings, or both.
IWMI has a net expense ratio of 0.68% on a contract that lasts through 08/28/25.
For more news, information, and analysis, visit the Tax-Efficient Income Channel.