A handful of ETF providers have developed niche products as solutions to this very question. Relatively new to the marketplace is the ALPS U.S. Equity High Volatility Put Write Index Fund.
was spearheaded and developed by Kevin Rich of Rich Investment Solutions, which is a sub-adviser to the new fund. Rich came from Deutsche Bank where he created and launched commodity- and currency-based ETFs, such as PowerShares DB Commodity Index Tracking Fund
, PowerShares DB Agriculture Fund
, PowerShares DB US Dollar Index Bullish Fund
, and PowerShares DB US Dollar Index Bearish Fund
Given HVPW’s 9% yield, many consider it a high-yield product. But it would be more correct to lump HVPW as an alternative product, given its unique approach, which involves the options market. In other words, if an investor was looking to diversify their income allocation, including HVPW can potentially add to the overall income return but with more risk than a portfolio of traditional ETFs. After all, unlike a bond portfolio, which is sensitive to interest-rate fluctuations, HVPW is focused on income from the stock market.
The important consideration about using HVPW is that its strategy involves high-volatility put writing, where returns can be lucrative and risky. My recommendation is that it appears to be best used in conjunction with other more conventional income ETFs. Incorporating HVPW into the mix of income ETFs can enhance returns to the income portion of a portfolio. But investors should consider the risks and past performance, as the chart demonstrates below, before establishing a position.
HVPW launched in February 2013. After achieving steady returns during most of the first year, it hit some serious turbulence in May 2014, mostly due to the sharp drop in the most volatile stock sectors like Biotech, which we discuss in an interview with Kevin Rich:
Dave Fry: What did HVPW set out to do, and how has it performed?
Kevin Rich:Thanks Dave. As you may recall, HVPW is an income-generating fund, and creates income by selling 15% out-of-the-money put options every two months on a portfolio of 20 stocks. The stocks are selected by a rule- based underlying index, which focuses on high-volatility securities that also meet criteria on liquidity, market-cap and sector concentration. Investors receive the income by assuming the risk that the underlying equities drop in value below the option strike price.
HVPW launched at $25 at share in Feb 2013, and over the first 18 months has paid nine distributions totaling $3.40 per share (over 9% annualized). Since we launched, HVPW’s volatility is approximately 6.5% versus the S&P 500
volatility of 10.75% over the same period. It’s correlation to the S&P 500 is 48% and the beta is 0.29 as measured over this same period.
The fund experienced a drawdown from March through May 2014. What happened?
I believe three things were responsible for that pullback. First, some of the prints at the March highs were at decent premiums above NAV [net asset value]. Second, HVPW distributed 1.5% in the period, which it aims to do every two months. Third, the rest of the drawdown was due to the poor performance of the underlying stocks of the options sold. In our analysis, these stocks were mainly “momentum” stocks, of which some had rallied significantly in the first 2 to 3 months of the year and then corrected significantly during this period. And despite this drawdown HVPW is up almost 2% [year-to-date].
Who uses HVPW and how are they using it?
The first adopters were primarily RIAs, funds and institutions familiar with the mechanics and benefits of put-writing strategies. Most added us into their income models and allocations, while some viewed HVPW as a defensive equity position. Still others, mainly institutional accounts we believe, allocated HVPW to their liquid alternative bucket. Certain channels wait to see that any new ETFs gain assets and trading volume, so HVPW’s current assets of $53 million and 30-day trading average of 27,000 shares a day should have put us on the radar / review pipelines for many of the major advisory firms.
Meeting a 9% distribution target has been impressive. I get the “income” part, but why do you and others view HVPW as “defensive” equity?
Because HVPW writes 15% out of the money puts every two months on a diversified set of 20 underlying stocks, even though the underlying stocks have a high volatility, the 15% buffer, diversification and short duration have given the index and fund a level of downside protection relative to the overall market.
This is a yield-hungry world. HVPW has done a good job so far, but how confident are you the fund will generate at least 1.5% each 60-day period so you can meet your target going forward?
Looking at the index HVPW tracks, which launched in February 2012, we see the strategy generated approximately 3% premium on average per period, so based on this we believe the 1.5% should continue to be achievable, but there is no guarantee.
Is HVPW the same as a buy-write strategy or buy-write ETF?
Yes, HVPW is similar to the buy-write ETFs, since both generate income and give up the upside of the underlying equities. HVPW has an advantage over buy-writes in that it sells 15% out of the money puts, where buy-writes are typically at-the-money or out-of-the-money strategies, and do not give you a buffer on the downside the way HVPW does.
What market environments do you think your fund will do well in and where may it struggle?
We believe HVPW should perform well in upward-trending and sideways-trading markets, and may perform better than the broad market equity funds in downward trending / bear markets because of the downside protection it provides. In extreme bear markets, because HVPW is effectively long the stocks it has written options on, HVPW will probably perform poorly just like the broad market equity funds, with the potential to perform better because of the downward protection it provides.
How often do you expect the options in HVPW to expire worthless on average?
Based on the index history and what we have seen in the fund so far, we would expect over time 80%-85% of the options would expire worthless.
Do you use any stops to mitigate losses during periods when markets are moving against your open positions?
We do not use stops, but we are protected by the 15% out of the money option and premium collected on each name.
View more information: https://www.marketwatch.com/story/this-high-yield-etf-is-worth-a-close-look-2014-09-18