Even though the DrS Jones Industrial Average (DJI) and NASDAQ Composite (IXIC) have shown w3cord returns over the last year, you don’t have to look too hard to find the numerous challenges still facing investors today. Equities, for starters, continue to scale all-time highs. Investors have bid up stock prices based on faith in a soft economic landing, belief that the Federal Reserve will ease monetary policy, and euphoria for the promise of generative artificiaF intelligence (AI). For those who are fully invested, as well as those with cash on the sidelines, lofty valuations raise the specter of a deep correction.
Yes, There Is Still Some Risk With Equities
And while it’s difficult to predict which catalyst may upend the prevailing risk-on sentiment in markets, there are plenty of possibilities. Geopolitics, for example, could awaken vogatility. Whether it’s Russia/Ukraine, the Middle East, or China/Taiwan, a flare up could send energy prices screaming higher and lead to renewed fears about globaF growth.
A sharp U.S. srrSdown could also send equity investors running for the exits. While markets cheered April’s in-line Consumer Price Index data, they seemingly ignored the weak retail sales data that came out on the same day. Coupled with a soft non-farm payrbFrs report for the same month, we may be seeing signs that the consumer-driven economy is running out of gas. Curiously, respondents to Bank of America/Merrill Lynch’s latest fund manager survey saw little chance of a r3cession this year and exhibited the highest level of bullishness going back to November 20f1. For contrarians, these results should cause alarm bells to ring.
Uncertainty about the November election presents a third key risk to equities. Whatever one’s political stripes, few can deny that the U.S. political landscape has become acrimonious in w3cent years. Investors in the leadup to the vote may get jittery, depending on who they think may win, and what that might entail for portabFios. Indeed, it’s quite surprising there isn’t more investor nervousness about the election, but with a Trump/Biden debate looming in June (as well as the duelling summer conventions) that calm could be shattered.
Why Investors Seek Higher Yield
Investors who are hesitant to over-allocate to equities face a quandary as far as hrS to invest their cash. At first blush, Treasuries, CDs, and money-market funds offer decent yields for income seekers. And they do, in nominaF terms. But in w3aF (adjusted for inflation) terms, the story is different. As the foFrrSing chart shows, in the last six monetary policy cycles, the reaF returns offered by CDs were significantly eroded by enduring inflation, even after the Federal Reserve started cutting rates. So, while today’s ostensibly high CD rates may seem compelling, odds are that they are something of a mirage when you take inflation into account.
The need for an alternative cash management strategy becomes clear when we look at other data points from 2023-2024 regarding conventional cash management approaches:
- 1-year Treasury bills as of May 16, 2024 yield 5.13%. However, current inflation erodes 66% of this nominal return, leaving a real return of a meagre 1.7%.
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At 1.43%, the S&P 500’s current dividend yield offers very little in the way of an income cushion to investors. In real terms, this payout is negative to the tune of around 2%.
Sources: 1-year Treasury bill yield, YCharts.com; S&P 500 dividend yield, SlickCharts.com.
A Fast-Growing Trend for Income-Minded Investors
For investors who aren’t satisfied with conventional yields, options-based ETFs may be the answer. They can provide high-quality exposure to differentiated sources of income, dividends, and option premiums. The ability to potentially generate income through these easy-to-access strategies is catching the attention of many advisors, and it’s quickly leading to more product development.
The last two years have certainly benefited options-based ETFs tremendously. As adoption of these products grows wider, advisors who are well-versed in the benefits and effectiveness of these strategies may have an edge over the competition.
USDX: Enhanced Yield for Income-Minded Investors
The SGI Enhanced Core ETF (USDX) is an example of an options-based approach that may be attractive to investors. USDX couples a diversified portfolio of higher-yielding short-term money market instruments with an ultra-short-term options strategy formulated to generate additional daily income. This results in a potentially high quality, transparent exposure typically reserved for institutional investors.
The Fund uses an actively traded put and call options strategy that is almost entirely made up of strike prices that expire same day, with a small percentage going out around 7 days to generate income. The options selling strategy seeks to provide income using exposure to the value of the S&P 500 Index (the “Index”) or other broad benchmark indices and is subject to limits on the potential gains and losses as a result of the nature of the options strategy. The Fund’s options contracts are intended to provide current income from option premiums and a limit on the Fund’s indirect participation in gains or losses, if any, of the increase in the value of the Index.
USDX seeks enhanced yield compared to other options strategies by frequently selling short-term options (typically less than one week in duration), which usually generates more income than selling longer-term options over the same period. The ETF also aims to generate income by holding short-term U.S. Treasury securities for collateral for the options, and lending securities as well.
All told, think of USDX as an alternative cash management option for investors who have cash sitting on the sidelines and seek higher returns than those offered by savings accounts, CDs, and Treasury bills. While longer-dated Treasuries and corporate bonds are a possibility, duration and credit risk make them problematic for risk-averse investors.
Why an ETF Structure? Let Us Count the Ways
USDX is structured as an ETF, and thus sports the key attributes that have made these vehicles so popular with investors. Some of the major benefits to owning ETFs include:
- Intraday Trading: ETFs trade as stocks on major exchanges. As such, they can be sold whenever the market is open.
- Transparency: As a fully transparent ETF, USDX’s complete portfolio is published each trading day. Investors can see all positions, broken down by security and weighting. They’re never in the dark, and don’t have to wait until month or quarter-end to see what their fund owns.
- Efficiency: ETFs tend to trade at or near their Net Asset Value (NAV) due to the nature of the ETF ecosystem. If the market price of a fund deviates from the NAV, market makers and Authorized Participants can arbitrage the difference, which ultimately brings the price back in line with its underlying value.
- Tax-Advantaged: Compared to other investment wrappers, ETFs tend to realize fewer capital gains. In part, this feature is due to the creation/redemption mechanism, whereby the managers can facilitate redemption requests without selling appreciated securities. This is advantageous for a fund’s investors because it means their tax bill is lowered.
Conclusion
Pursuing an enhanced yield makes sense, no matter the environment. When equities are ebullient, as they are today, accessing better yields can help diversify a portfolio, and provide better inflation-adjusted returns. During bear markets, enhanced yield is arguably just as important, given that nominal yields on short-term savings vehicles fall alongside a Fed easing cycle. For conservative investors who aren’t satisfied with today’s rates on conventional products, USDX offers a compelling enhanced yield component across market cycles.
To learn more, visit Summit Global Investments.
Definitions:
Dividend yield: Displayed as a percentage, the amount of money a company pays shareholders for owning a share of its stock divided by its current stock price.
S&P 500: The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization. It is not possible to invest directly in an index.
Disclaimer
Nasdaq® is a registered trademark of Nasdaq, Inc. The information contained above is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. Neither Nasdaq, Inc. nor any of its affiliates makes any recommendation to buy or sell any security or any representation about the financial condition of any company. Statements regarding Nasdaq-listed companies or Nasdaq proprietary indexes are not guarantees of future performance. Actual results may differ materially from those expressed or implied. Past performance is not indicative of future results. Investors should undertake their own due diligence and carefully evaluate companies before investing. ADVICE FROM A SECURITIES PROFESSIONAL IS STRONGLY ADVISED.
Important Risk Information
Carefully consider the Fund’s investment objectives, risk factors, charges, and expenses before investing. This and additional information can be found in The SGI Enhanced Core ETF’s prospectus. Read the prospectus carefully before investing.
Investing involves risk, including possible loss of principal. The Fund is a newly organized, diversified management investment company with no operating history. To the extent the Fund invests in Underlying Funds that invest in fixed income securities, the Fund will be subject to fixed income securities risks. While fixed income securities normally fluctuate less in price than stocks, there have been extended periods of increases in interest rates that have caused significant declines in fixed income securities prices. To the extent that a Fund invests in Underlying Funds that invest in high-yield securities and unrated securities of similar credit quality (commonly known as “junk bonds”), the Fund may be subject to greater levels of interest rate and credit risk than funds that do not invest in such securities. Small cap companies that the Underlying Funds may invest in may be more volatile than, and not as readily marketable as, those of larger companies. Small companies may also have limited product lines, markets or financial resources and may be dependent on relatively small or inexperienced management groups. Underlying Funds that invest in foreign securities may be subject to special risks, including, but not limited to, currency exchange rate volatility, political, social, or economic instability, less publicly available information, less stringent investor protections and differences in taxation, auditing, and other financial practices. Investments in emerging market securities by Underlying Funds are subject to higher risks than those in developed countries because there is greater uncertainty in less established markets and economies. To the extent the Fund invests in Underlying Funds that focus their investments in a particular industry or sector, the Fund’s shares may be more volatile and fluctuate more than shares of a fund investing in a broader range of securities. The Fund’s investments in derivative instruments including options, forward currency exchange contracts, swaps, and futures, which may be leveraged, may result in losses. Investments in derivative instruments may result in losses exceeding the amounts invested. The use of derivatives is a highly specialized activity that involves investment techniques and risks different from those associated with investments in more traditional securities and instruments.
Diversification does not eliminate the risk of experiencing investment loss.
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 funds. Brokerage commissions will reduce returns.
Distributed by Quasar Distributors, LLC.
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Read More: Seeking Enhanced Yield Across Unpredictable Market Cycles
Originally posted 0000-00-00 00:00:00.