Leverage & Income?

Here's a useful chart from Jake at Econompic on Twitter.

He said that in real terms, investors may never get back to even. This sort of thing is exactly what I blogged about so much, albeit elsewhere, that I wanted to avoid. Going forward, who knows what interest rates further out the curve will do. Right here right now, there's no visibility for 7% on the ten year or further out but if it happens, the price drop would be almost 30%. Yes, an individual bond would return to par....but that really is a grasp to rationalize a bad outcome. For a bond fund, there of course is no par value to return to. 

At what yield would you be willing to go on what could be a wild ride for maybe eight and half years. At some short maturity, the volatility would go away which is why I said eight and a half. In previous posts, I've talked about 7% as being close to a tipping point that would get me interested realizing that may never come. I do know that 5% wouldn't be enough though. 

Bloomberg reported that KKR is going to change some or most or maybe even all of its strategy from an operating company managing various funds for investors to becoming a "mini-Berkshire Hathaway." Flipping the entire company that way seems unlikely but I don't know. The reason to mention this is we use KKR for blogging purposes as a way not to access private equity but more like how to benefit from the fees. Again, it's not clear to what extent the company is going to change but it's worth following given how we've talked about the company before although we've used Blackstone (BX) far more often in this context. 

Roundhill came out with a few ETFs that combine a little leverage and derivative income. We can look at the AAPL WeeklyPay ETF (AAPW) to get a sense of the idea. The leverage is 1.2x resetting once a week and I found buried deep in the prospectus it will pay weekly <joke>. The holdings list as having 19% in Apple common stock and 99% in a swap position the presumably to get the leveraged equity exposure and the derivative income. For all the fun we have playing with leveraged funds and derivative income funds, of course we're interested in what this will be.

In looking at leveraged funds other than 2x long S&P 500, it is difficult to fund too many that "work" for any longer period of time. Maybe there can be less variability with such a modest leverage amount. The idea of 1.2x would be interesting too in some sort of modest capital efficiency application if funds that just do that every hit the market and gain any traction. 

The chart compares AAPW to the underlying and the YieldMax equivalent which is APLY. The chart is a little distorted, AAPW has already paid four dividends totaling $0.79 which adds about 1.5% back in to the total return which gets it pretty close to 1.2x the decline in the common. All shows for such a short period is not a horrendous first impression. 

I wanted to add an important follow up point to the discussion the other day about the Innovator Defined Wealth Shield ETF (BALT). We dug in a little on whether it could function as a fixed income substitute trying to make it crystal clear it is not an equity proxy. BALT spares holders the first 20% down in the S&P 500 and then will go down with the index from there. From the literature, if the S&P 500 dropped 100%, BALT would drop 80%. 

I made a comment that if it got down 18 or 19%, maybe just sell it if there was a concern that the index would breach the 20% threshold. Note that the 20% resets quarterly. If on the last day of the quarter, the S&P was sitting on a 19% decline and assuming BALT was working, it would be essentially flat. The next day the fund would have a new buffer 20% down from there. The S&P 500 doesn't fall 20% in a quarter very often but obviously it can happen, it happened in Q1 of 2020 and the 3rd quarter of 2008 and I imagine there were others. 

If someone is actually going to use this, it is crucial they sell before the 20% threshold is hit. The current cap, the most it can go up, for the quarter expiring on Monday is 2.41%. In what is admittedly an extreme long shot outcome, if the S&P fell 40% inside one calendar quarter, BALT would be protected for the first 20%, then ride down the next 20%, the quarter ends with BALT down 20%, the new quarter starts and BALT is capped and would miss most of any fast snapback and in the "wrong" scenario could take four years to get back to even if successive cap periods are in the mid-twos. 

If that isn't written clearly, just sell if it's down close to 20% inside of one quarter. It wouldn't be a panic sale because assuming no malfunction, the fund wouldn't be down. You'd be mitigating a possible, even if unlikely, structural risk to the product. 

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