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 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 potentially 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.
“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,” Molchan added.
Through the combination of potential 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.
VIX – Cboe Volatility Index, or VIX, is a real-time market index representing the market’s expectations for volatility over the coming 30 days. Investors use the VIX to measure the level of risk, fear, or stress in the market when making investment decisions.
MBS – A mortgage-backed security is a type of asset-backed security which is secured by a mortgage or collection of mortgages. The mortgages are aggregated and sold to a group of individuals that securitizes, or packages, the loans together into a security that investors can buy.
S&P 500 – A market-capitalization-weighted index of the 500 largest U.S. publicly traded companies. The S&P is a float-weighted index, meaning company market capitalizations are adjusted by the number of shares available for public trading.
Nasdaq-100 – A basket of the 100 largest, most actively traded U.S companies listed on the Nasdaq stock exchange.
Options Collar Strategy – An options trading strategy that is constructed by holding shares of the underlying stock while simultaneously buying protective puts and selling call options against that holding.
Covered Call – A financial market transaction in which the seller of call options owns the corresponding amount of the underlying instrument, such as shares of a stock or other securities.
Protective Put – A risk-management strategy using options contracts that investors employ to guard against the loss of owning a stock or asset.
Near-at-the-Money – An options contract whose strike price is close to the current market price of the corresponding underlying security. “Close to the money” is an alternative phrase, designating the same situation.
Out-The-Money (OTM) – An expression used to describe an option contract that only contains extrinsic value. These options will have a delta of less than 50.0. An OTM call option will have a strike price that is higher than the market price of the underlying asset.
This article was prepared as part of Nationwide’s paid sponsorship of ETF Trends.
Performance data quoted represents past performance; past performance does not guarantee future results. Index performance is not illustrative of fund performance. One cannot invest directly in an index. Please call 1-877-893-1830 for fund performance.
ETFs, hedge funds, equities, bonds, and other asset classes have different risk profiles, which should be considered when investing. All investments contain risk and may lose value. Investing involves risk, including the possible loss of principal. Shares of any ETF are bought and sold at market price (not NAV), may trade at a discount or premium to NAV and are not individually redeemed from the Fund. Brokerage commissions will reduce returns. The Fund’s return may not match or achieve a high degree of correlation with the return of the underlying index.
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KEY RISKS: The Fund is subject to the risks of investing in equity securities, including tracking stock (a class of common stock that “tracks” the performance of a unit or division within a larger company). A tracking stock’s value may decline even if the larger company’s stock increases in value. The Fund is subject to the risks of investing in foreign securities (currency fluctuations, political risks, differences in accounting and limited availability of information, all of which are magnified in emerging markets). The Fund may invest in more-aggressive investments such as derivatives (which create investment leverage and illiquidity and are highly volatile). The Fund employs a collared options strategy (using call and put options is speculative and can lead to losses because of adverse movements in the price or value of the reference asset). The success of the Fund’s investment strategy may depend on the effectiveness of the subadviser’s quantitative tools for screening securities and on data provided by third parties. The Fund expects to invest a portion of its assets to replicate the holdings of an index. Correlation between Fund performance and index performance may be affected by Fund expenses and because the Fund may not be invested fully in the securities of the index or may hold securities not included in the index. The Fund frequently may buy and sell portfolio securities and other assets to rebalance its exposure to various market sectors. Higher portfolio turnover may result in higher levels of transaction costs paid by the Fund and greater tax liabilities for shareholders. The Fund may concentrate on specific sectors or industries, subjecting it to greater volatility than that of other ETFs. The Fund may hold large positions in a small number of securities, and an increase or decrease in the value of such securities may have a disproportionate impact on the Fund’s value and total return. Although the Fund intends to invest in a variety of securities and instruments, the Fund will be considered nondiversified. Additional Fund risk includes: Collared options strategy risk, correlation risk, derivatives risk, foreign investment risk, and industry concentration risk.
Nasdaq-100 Index: An unmanaged, market capitalization-weighted index of equity securities issued by 100 of the largest non-financial companies, with certain rules capping the influence of the largest components. It is based on exchange, and it is not an index of U.S.-based companies. Market index performance is provided by a third-party source Nationwide Funds Group deems to be reliable (Morningstar). Indexes are unmanaged and have been provided for comparison purposes only. No fees or expenses have been reflected. Individuals cannot invest directly in an index.
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Financial advisors who are interested in learning more about income and managing risk can watch the webcast here on demand.