ETF Trends CEO Tom Lydon discussed the Nationwide Risk-Managed Income ETF (NUSI) on this week’s “ETF of the Week” podcast with Chuck Jaffe on the MoneyLife Show.
NUSI is an actively managed portfolio of stocks included in the Nasdaq-100 Index and an options collar. Per index rules, the fund only invests in the top 100 largest by market cap, nonfinancial stocks listed on NASDAQ. A collar strategy involves selling or writing call options and buying put options, thus generating income to hedge some downside risk. The strategy seeks to generate high current income monthly from any dividends received from the underlying stock and the option premiums retained.
When looking at why NUSI is being considered, Lydon explains how investors may consider a new risk-managed income ETF strategy that could generate higher income relative to traditional income-focused investments. Getting a lay of the land, 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 severe hit to the upcoming earnings season ahead.
The economy is also at the edge of a recession after the government’s push toward self-isolation halted the economy. Many anticipate a sharp contraction in the second quarter before turning back to positive growth in the fourth quarter.
Listen to Tom Lydon Discuss NUSI ETF With Chuck Jaffe:
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.
As a result, 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.
NUSI is a better alternative for fixed-income investors. The ETF will try to achieve high monthly income generation, portfolio volatility reduction, reduced duration risk, and interest rate sensitivity, capital appreciation from equity participation, downside risk mitigation and enhanced tax efficiency of index options.
The fund uses options-based strategies to help investors target high current income with less risk relative to traditional income-focused investments. It also seeks to provide investors with a measure of downside protection with potential upside participation. Investors have long capitalized on covered call options strategies for income generation or protective put options strategies to protect against and limit losses.
Additionally, NUSI uses an options trading strategy called a protective net-credit collar to generate income. The options strategy sells an upside call option and uses a portion of the proceeds received to buy a put option to hedge downside risk on an underlying portfolio of securities.
A covered call refers to an options strategy where an investor writes or sells a call option on an asset which they already own or bought on a share-for-share basis to generate income via premiums derived from the sale of the call options. A protective put is an options strategy where an investor purchases a put option on an asset which they already own or bought on a share-for-share basis to limit potential losses. The protective put will cause profits derived from the strategy to be reduced by the premium paid for the put, but it limits the maximum potential losses.
NUSI utilizes 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 are remaining options premium, the ETF will reinvest in the underlying stocks for potential upside participation.
As for how things are going currently, it’s been so far so good during the coronavirus selling. Amid the ensuing sell-off, NUSI has maintained a high, stable yield profile, relative to other income-focused investment solutions. From 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.
So, where is the best fit? NUSI 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, the fund can be a volatility dampener that may augment existing allocations as well as a tool that may aid in supplementing current income.
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