ETF Sophistication Continues To Evolve

One of the fun things about having this blog is the ongoing search for improving portfolio construction, discovering new funds and whether they could be part of the solution. Hint: most aren't but it is a fun and interesting exercise and every so often a fund does make the cut. With that in mind I wanted to look at a couple of new (to me) funds and circle back to a couple we've looked at before to see if we can glean anything new. 

A few weeks ago we looked at funds that overlay buywrite strategies on top of fixed income ETFs. So the iShares 20+ Year Treasury Bond Buywrite Strategy ETF (TLTW) simply owns TLT and sells calls against the shares. There are three such funds from iShares, the last time I looked, the other two are LQDW which is IG corporates with covered calls and HYGW which is high yield with covered calls. No such fund for iShares Aggregate Bond Fund (AGG) which seemed odd but that's because someone beat them to it several years earlier with the Overlay Core Bond ETF (OVB). The fund owns the AGG ETF and sells calls against the position. There's not a lot of moving parts to these funds, so simple is good but just because they are simple doesn't mean they can't offer a sophisticated outcome. Do they actually do that though? 

OVB yields 5.19% versus 3.08% for AGG, both numbers from Yahoo Finance. Where that is trailing yield, I would expect they'd both go up from here. AGG has a slightly better CAGR and a meaningfully lower standard deviation which surprises me. Ideally, the call writing would help dampen volatility but that hasn't been the case thus far. 

Then I had the idea of building 60/40 with buywrite S&P 500/AGG and just plain vanilla S&P 500/AGG to see if the covered calls help that way. I also threw in a mix and match of plain vanilla S&P 500/OVB.

XYLD is S&P 500 plus covered call from Global X.

Portfolio 2 obviously lags badly due to the covered call strategy. There are plenty of back tests that show much better upcapture from equities plus covered calls but you also get this sometimes. SPY plus OVB delivers an interesting result. Just 29 basis points less CAGR with 96 basis point drop off in standard deviation. While that is interesting it might be a distinction without a difference. Even though the standard deviation is less, in 2022, SPY/OVB lagged plain vanilla 60/40 by 189 basis points. 

If we sub in the JP Morgan Equity Premium ETF (JEPI) in for XYLD, we get much closer to SPY/AGG. The JEPI/OVB combo only tests back to Jan 2021. Its CAGR lags SPY/AGG by only 3 basis points and its standard deviation is better by a whopping 247 basis points. That sounds good but the seemingly strong relative performance is mostly attributable to a very good 2022 for JEPI that may not be repeatable.  

I'm not willing to take on the duration in the covered call fixed income arena but I should note that Portfoliovisualizer has TLTW down 1.42% on a total return basis this year compared to a drop of 9.23% for TLT. That is impressive but if you compare the two on Yahoo Finance, the nominal price decline is about the same for both.

As opposed to using a covered call equity fund as a replacement for market cap weighting (MCW), I would think of it more as complimentary exposure to MCW, in much smaller proportion to MCW. Another use could be along side something very volatile in pursuit of a blend that produces higher returns and less volatility than simple MCW.

Changing fields completely to a fund that I don't think we've mentioned before, the Alpha Architect Tail Risk ETF which has the humorous symbol CAOS. I used to hold the Cambria Tail Risk ETF (TAIL) for clients. TAIL has been hurt by owning longer duration fixed income. The decline in the fund's bond holdings have more than offset any benefit from the puts owned. CAOS appears to be a better mouse trap by just having short duration cash proxies. Very short. The track record doesn't go back very far but here's what we can look at.

BOXX is another fund from Alpha Architect, the 1-3 Month Box ETF which essentially maintains an options combo that delivers a cash like return. It is perhaps the most horizontal line alternative I've ever seen. The reason to add BOXX to this chart is that BOXX is the largest holding in CAOS at about 65% of the fund. TAIL could be a replacement for long duration bonds with crash protection added on top and CAOS could be a replacement for short term fixed income with crash protection added on top. 

BOXX is on a list of funds I watch and it seems like it just goes up 1-3 pennies every single day. Thus far the put option overlay has not hurt performance of CAOS. CAOS isn't quite the straight line that BOXX is but it is close, much more so than TAIL. 

There is something I can't figure out about CAOS though. Apparently it used to be a mutual fund. It was called the Arin Large Cap Theta Fund and had symbol AVOLX. In 2019 up until the Pandemic Crash, it looked very similar to how CAOS has looked since March. The huge spike up in March of 2020 makes sense, it's crash protection. But there were long stretches where volatility profile looked nothing like what CAOS does now. BOXX didn't exist until last December so not sure if they were just using a different cash proxy or the strategy got changed along the way. I will work on trying to find out. CAOS is promising. If it is a horizontal line 95% of the time and then goes up when the market drops, that is an appealing combo but that is a big if. 

Lastly there's a new suite of TIPS funds from iShares. They are defined maturity like Invesco Bulletshares. Symbol IBIA matures in 2024, IBIB matures in 2025, then every year through 2033 with symbol IBIJ. I am test driving IBIB in one of my accounts as a possible better mousetrap for client holding STPZ which targets 1-5 year TIPS.

The iShares TIPS Bond ETF (TIP) was the first one in the space. I owned that for clients from the beginning but then it occurred to me that long duration is long duration and that I was taking interest rate risk with TIP so I switched to STPZ. That must have been at least ten years ago now. 

 

You can see that STPZ still went down in 2022 but quite a bit less than TIP and AGG and this year it has trended sideways while TIP is down 3.7% per Yahoo. I can remember seeing that people were surprised at how much TIP could go down last year. I'm not sure if they expected the inflation bump adjustment in the par value to offset the interest rate price declines or something else but either way, I feel like I dodged a bullet. 

Here's a look at STPZ and TIP on a total return basis for 2022 from Portfoliovisualizer.

 

A quick go back on AVOLX. ETFs are absolutely the better mousetrap versus mutual funds but there are plenty of interesting and helpful strategies in mutual funds. I would not turn my nose up at something just because the wrapper is a mutual fund. AVOLX may have been a great mutual fund or a lousy one, don't know but it is an interesting idea. 

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