4 ETFs for a 7% Yield Portfolio
Many income seekers, including retirees, have resigned themselves to the fact that their portfolios just may never generate the kinds of dividends that they want, explains David Dierking, editor of ETF Focus on TheStreet.
But all hope is not lost! ETF issuers recognize the struggles of the current low yield environment and have developed solutions to address them. Several of the ETFs that have been launched over the past year or two are using some less conventional, more complex strategies in order to accomplish these goals.
More from David Dierking: A Simple 4 ETF Portfolio Strategy
There will be risks that come with investing in each of the ETFs I'll discuss below, as should be expected with any investment that yields around 7% in today's environment.
When you consider them together as part of a single investment collectively, however, you'll find a relatively diversified portfolio that consists of large-cap stocks, some international exposure, a mix of investment-grade and high yield corporate and government bonds and a splash of alternative investments to diversify overall risk while providing a yield boost.
Nationwide Risk-Managed Income ETF (NUSI)
Current Yield: 7.74%
Objective: An income solution that targets high current income and seeks to provide investors with a measure of downside protection in falling markets and potential for upside participation in rising markets.
I think it's one of the most interesting high yield opportunities available to investors today. NUSI starts with a core position replicating the Nasdaq 100 index. On top of that, it layers on an options collar strategy, which consists of two components.
First is a covered call strategy in which the fund can write call options on up to 100% of the portfolio's holding in order to generate high income. Second is a protective put strategy in which the fund uses some of the premiums generated from the written calls in order to buy put options on the index that help mitigate downside risk.
The covered call positions end up limiting upside, but that's countered by the protective put limiting potential downside. The resulting portfolio ends up having lower volatility to both the upside and downside, but generates roughly an 8% distribution yield thanks to the net premiums received from the options activity.
How much less volatility? According to historical betas and standard deviations of returns, NUSI is about 50-60% as volatile as the Nasdaq 100 index. The COVID-19 recession in 2020 provided a good example of what kind of downside protection investors could expect. From peak to valley, NUSI experienced a max drawdown of around 10% compared to a nearly 30% correction in the Nasdaq 100.
JPMorgan Equity Premium Income ETF (JEPI)
Current Yield: 7.18%
Objective: Generates income through a combination of selling options and investing in U.S. large cap stocks, seeking to deliver a monthly income stream from associated option premiums and stock dividends.
JEPI is an actively-managed fund that you could consider as something of a hybrid between a traditional covered call ETF and a large-cap low volatility ETF. It has a bit of an unconventional structure, but the finished portfolio looks pretty traditional.
The fund can be broken down into two components - 1) an allocation to equity-linked notes that are designed to look and behave like an S&P 500 covered call strategy all within a single security and 2) an actively-managed segment that focuses on research, valuation and security selection that has a lower overall volatility than the S&P 500.
Currently, about 16% of the fund's assets are invested in the ELNs with the remaining going towards the individual equity positions. While it doesn't have a target distribution yield, it has consistently paid an annualized rate of around 7-8% historically.
Even though its focus is mostly on the components of the S&P 500, JEPI, not surprisingly, has a higher correlation with not just the big low volatility ETFs, but also some of the bigger dividend growth ETFs, such as the Vanguard Dividend Appreciation ETF (VIG) and the WisdomTree U.S. Dividend Growth ETF (DGRW).
Strategy Shares Nasdaq 7HANDL Index ETF (HNDL)
Current Yield: 7.00%
Objective: The index invests a 50% allocation to fixed income and equity ETFs and a 50% allocation to a “Dorsey Wright Explore Portfolio,” a tactical allocation with U.S. fixed-income, U.S. blend, U.S. equity and U.S. alternative assets. It has a policy to pay monthly distributions of approximately an annualized 7.0% of the fund's net assets.
HNDL, which is a fund-of-funds, has a target distribution strategy that you often find in the closed-end fund universe. On the plus side, its policy of monthly distributions is a nice added bonus for income seekers, while the target yield offers a high degree of predictability.
On the down side, the fund's distribution is dependent upon the performance of the fund. If the share price goes down, your dividend also goes down.
Just like the other funds mentioned above, HNDL also splits its portfolio into two pieces. The first is a "core" position, which includes broadly diversified equity and fixed income ETFs that would resemble a traditional diversified long-term portfolio using a 30/70 allocation.
The second is the "Dorsey Wright Explore Portfolio", a tactical allocation with U.S. fixed-income, U.S. blend, U.S. equity and U.S. alternative assets, or categories that have historically provided high levels of income.
The fixed distribution strategy is the unique feature and must be watched closely because it has the potential to be good or bad. Because it aims to distribute an annualized rate of 7% of assets, HNDL needs to generate that type of total return in order for it to "stay above water".
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The fund will, of course, distribute any income that is generated, but any shortfall from the 7% target needs to be made up by the fund's net assets. That could include capital gains generated by the fund or what's considered a "return of capital", which is essentially returning the investor's initial investment.
A distribution without the income/gains to support it can result in what's considered a "destructive" return of capital. Investors want to avoid destructive ROCs because they can erode the fund's asset base over time. In HNDL's case, the returns of capital it has been making over time appear to be of the non-destructive variety and may actually be beneficial.
Over its lifetime, HNDL's NAV has risen by 3%, which means the distributions are being supported. ROCs that are a return of the initial investment are actually non-taxable, so there's some benefit on that front as well.
GraniteShares HIPS U.S. High Income ETF (HIPS)
Current Yield: 8.20%
Objective: To provide a simple and diversified exposure to 4 alternative income categories - MLPs, REITs, BDCs and Closed-end funds - while paying a monthly distribution providing a regular and steady source of income.
Here's the non-traditional segment of the 4 ETF portfolio. The first three funds mentioned generally focus diversified portfolios of equities, fixed income and instruments that are tied to the most well-known indexes. HIPS is not that type of fund.
It invests in a mix of traditional high yield investments — REITs, MLPs, BDCs and closed-end funds. These are the types of products I mentioned earlier when talking about drifting far out onto the risk spectrum in order to capture a high yield. Used in moderation, they're perfectly fine to add as a satellite holding to a core portfolio.
The low correlation to traditional asset classes actually ends up helping to reduce overall portfolio risk even though the individual components are riskier. You don't necessarily want to go overboard here since they will make the overall portfolio riskier when added beyond a certain point, but modest use has benefits.
The 7% Yield Portfolio
Let's take a look at the 4 ETFs side-by-side along with their yields and allocations I've chosen before discussing why I set it up this way.
Each of these components currently yields 7% or more on a forward-looking basis (HNDL's yield fluctuates a little based on current share price movements, but I'm using the 7% target here).
Those yields can and do change over time based on prevailing market conditions, so these numbers need to be monitored for movements both higher and lower.
I've given allocations to the three "core" ETFs — NUSI, JEPI and HNDL — of between 25-35%. NUSI gets the smaller 25% allocation because it's focused on the narrower Nasdaq 100 instead of the broader market.
As constructed, the 4 ETF portfolio consists of around 70% equities, 21% fixed income and 9% that's categorized as "other" or cash. 85% of the equity holdings fall into the large-cap bucket.
If there's one drawback to this portfolio, it's that it's heavily weighted towards U.S. large-cap stocks. Less that 3% overall goes towards international stocks and just over 3% to international bonds.
While tech, not surprisingly, accounts for the largest percentage of this portfolio at more than 25% of assets, there are 7 distinct sectors which receive allocations of at least 8%. This offers investors a really nice diversified mix of different exposure that could benefit in multiple market environments.
The fixed income component looks a little less diversified. It's heavily allocated to non-investment grade bonds, which could be troublesome given where yields/spreads currently stand in consideration of overall market and political risks.
The overall duration of the fixed income portion is around 5-6 years, so this is fairly in line with what you'd expect from an intermediate-term bond portfolio. There's some risk here since yields have almost nowhere to go but up, but I don't view interest rate risk is a major concern here.
Conclusion
A challenging yield environment calls for unconventional portfolio solutions. Fortunately, there is still a way to achieve a high yield while maintaining diversification and not venturing too far out on the risk spectrum.
This portfolio focuses mostly on lower volatility equities, risk-mitigated strategies and fixed income, so it still has the look of a traditional portfolio allocation in the pursuit of high yield. Better yet, it comes in a simple package of 4 ETFs, so there's not the need to add fund on top of fund in order to spread out risks.
There will always be risks in trying to achieve a high yield in this environment. This combination of high yield ETFs should do a solid job of providing diversification and risk mitigation while allowing income seekers to start collecting some larger checks.
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