As we struggle with yield generation in a low-rate environment, investors may consider a new risk-managed income ETF strategy that could generate higher income relative to traditional income-focused investments.

In the recent webcast, Generating Income and Managing Risk in Today’s Market, Mark Hackett, Chief of Investment Research, Nationwide, outlined the current environment marked by a battered equity market with the S&P 500 suffering through a pullback of over 30% from its peak and the CBOE Volatility Index, or so-called VIX, spiking to heights last seen during the 2008 financial crisis. Meanwhile, bond market liquidity is at critical levels with wide spreads between assets as investors shift to safety and turn to cash.

Nevertheless, the government has stepped in to try and catch the economy’s fall with a fiscal $2 trillion stimulus package on deck, which should help support small businesses, corporations, households, states, and local governments, among others. The Federal Reserve has also stepped up with several loose monetary policies, including unlimited Treasury and MBS purchases, money market mutual fund liquidity facility, commercial paper funding facility and primary dealer credit facility, among others.

The equity markets, though, remain depressed, and many expect a tough hit to the upcoming earnings season ahead. The economy as also at the edge of a recession after the government’s push toward self-isolation halted the economy. Nationwide anticipates a 5.0% contraction in real GDP over the second quarter, followed by a 0.5% drop in the third quarter, and then turning around in the fourth quarter with a 3.3% expansion.

The ongoing push toward safety, coupled with the Federal Reserve’s easing programs have driven down rates. Consequently, The steady decline in treasury yields has made it exceedingly more difficult for investors to generate reliable streams of income from traditional bond investing.

Consequently, Jonathan Molchan, Managing Director and Portfolio Manager, Harvest Volatility Management, pointed out that investors are increasingly taking on higher risk in search of attractive yields. These alternatives include high dividend stocks, REITs, emerging market debt, high-yield bonds, preferred stock, and MLPs. However, these alternative income-generating ideas come with risks or tradeoffs, such as interest rate sensitivity as well as risks associated with duration, inflation, commodity exposure, and leverage.

Knowing About NUSI

As an alternative to these riskier yield-generating investments, Nationwide recently launched the Nationwide Risk-Managed Income ETF (NYSE Arca: NUSI) that uses options-based strategies to help investors target high current income with less risk relative to traditional income-focused investments. It seeks to provide investors with a measure of downside protection with potential upside participation.

The Nationwide Risk-Managed Income ETF incorporates options exposure to help generate income and mitigate risk as a way to enhance total returns. Investors have long capitalized on covered call options strategies for income generation or protective put options strategies to protect against and limit losses.

“In the midst of the ensuing sell-off, NUSI has maintained a high, stable yield profile, relative to other income-focused investment solutions,” Molchan said.

“Inception to date, NUSI has significantly outperformed other income-focused asset classes, extending this outperformance in the wake of an uptick in volatility and a market sell-off,” he added.

Through the combination of income generation and downside protection, NUSI can benefit investors and advisors as it’s a solution that can complement a traditional 60/40 allocation, and it can be used as a bond alternative that can afford investors flexibility across varying market cycles. Also, NUSI can be a volatility dampener that may augment existing allocations as well as a tool that may aid in supplementing current income.

NUSI follows a three-step strategy. First, it fully replicates the constituents of the Nasdaq-100 Index. Secondly, the ETF deploys a rules-based options collar strategy that combines a covered call and a protective put. FOr the covered call component, a near-at-the-money to out-of-the-money Nasdaq-100 Index call option is sold, with the intent of generating options premium. For the protective put component, the strategy uses a portion of the options premium received to purchase an out-of-the-money Nasdaq-100 Index put option, which seeks to fully hedge the portfolio below the current market price and protect against potential losses in the equity portfolio.

Finally, a monthly distribution is paid out using a portion of the net-credit generated by the collar. If there is remaining options premium, the ETF will reinvest in the underlying stocks for potential upside participation.

Financial advisors who are interested in learning more about income and managing risk can watch the webcast here on demand.