DaveFry

How does an investor get yield in a low interest-rate environment?

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.

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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 SPX, +1.26%  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].