There was an interesting article at Seeking Alpha about how to build a portfolio that yields 9%.
Those are some very big weightings. In order, PFFA is a preferred stock ETF, ET is an MLP, BXSL is a BDC, JEPI is a covered call fund, RQI is a a real estate CEF and UTF is an infrastructure CEF. A couple of them are very new so there is no great way to back test this.
The chart though uses longer standing substitutes for some of the holdings that might give a little color about what to expect. I build that back test not reinvesting the dividends because the premise of the article is taking out all the income. For comparison, from 2008 forward, the S&P 500 had a CAGR of 7.65% and a standard deviation of 16.19%. At the start of 2024 you can see what the balance in each holding would have been and for an S&P 500 Index ETF the balance would was $32,509 after starting at $10,000. RQI and UTF have each been around since at least 2008 and they too have compounded negatively, again, we are excluding the income because that is the author's premise.
I am not picking on covered call fund even though the track record in this context is pretty bad when you take out all the income. Maybe JEPI will be different. I'm not kidding about that, JEPI might turn out to be different, that it might have a large payout and still go up in price. I don't know but I think it is possible. It is up some, on a price basis since inception but down a good bit from it's late 2021 high. To be clear, I am say JEPI might be different but I don't know and I am not buying the fund.
These issues aren't deal killers for having some exposure to these segments of the market but right now we are in a 4-5% world. Getting 9% out of an entire portfolio is going to entail a good amount of risk, in this instance that risk includes taking on volatility that is higher than the S&P 500. There is also inflation risk. From the above chart, $30,000 invested in 2008 is now worth $36,875. $30,000 into the S&P 500 on the same day which would have been dreadful timing is worth $97,526.
A nine percent withdrawal rate is extremely unlikely to be sustainable. The income sectors paying that much have a tremendous amount of volatility and occasionally they get absolutely murdered during market events. Not often but more than once. BDCs, MLPs and the like can be tools to include to help lift the overall yield of a portfolio. Putting 5% into three or for of these for a total of 15-20% would kick up the yield a good bit without sacrificing all growth but 20% would also ramp up the volatility.
Regarding covered call funds, I think they are different than these others. I don't think they must have more volatility. They are sold as having less and that has been the case with JEPI since its inception as well as with XYLD and PBP since their respective inceptions.
In some circles volatility is considered an asset class. We've looked at this before and my take on vol as an asset class is more like it can be a tool to harness for various portfolio effects. Going long volatility like through a VIX product can act as a hedge during market declines for example, of course those funds have a whole host of risks which result in them tending to go down 99% and then reverse splitting. Tail risk funds buy volatility by buying index put options and they erode to varying degrees, less than long VIX funds, but have a good chance of helping when markets go down.
Volatility can also be sold. Selling volatility can either be insanely risky or relatively low risk. Inverse VIX funds sold volatility which turned out to be picking up nickels in front of a fast moving steamroller. The strategy worked great for a while and then they all shut in what Eric Balchunas dubbed Volmageddon. Covered call funds sell volatility. There's no reasonable risk of broad index covered call funds going to zero. In a down market the underlying equities in those funds will track with the broad market lower and hopefully the call premium will offset some portion of the decline. They harness short volatility in pursuit of a specific effect. Maybe they achieve that effect, maybe they don't, up to you.
We have seen more funds that sell volatility by selling puts hit the market. WisdomTree Putwrite (PUTW) is one of the longer standing funds. Defiance has hit the market recently with funds that sell 0dte puts. Defiance thinks their funds will look like covered call funds.
Does PUTW look like a covered call fund? That is up to the end user but it is noteworthy that PUTW held up a little bit better than market cap weighted (MCW) and covered calls during the Pandemic Crash of 2020.
It's not easy to see but PUTW was slightly better. Maybe it is a lower vol/lower return, higher yielding proxy for equities? That is the recent track record, anyway. The increase in interest rates means PUTW can pay more out because it owns a lot of T-bills to collateralize the puts. The effect might have a place in a portfolio even if being 100% in something like this doesn't make sense. Same with 9% yielders, they might have a place in a portfolio but being 100% in them doesn't make sense.
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2 comments:
Hi Roger,
I have purchased NEEPR, a mandatory convertible bond for NEE. It is currently paying 9+%. I have wanted to purchase NEE for my portfolio, but it was not priced where I viewed it as good value until recently. Given the current fall in stock price, I can use the mandatory to achieve my desired position, and benefit for 18 months more from a 9% dividend. This is one position in my portfolio, about 3% commitment. I view this as an equity position, not income. Just equity with benefits! My father worked for FPL for over 30 years and had 3% of his salary in a stock purchase plan. This position became a huge benefit to my mother in her retirement years for income.
Hi Sam
Yes, it has been quite a while since the common struggled like it has recently. Thinking of it as more equity exposure is a good call. I don't think I knew that that your dad worked for FPL.
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