Fun With Funds

Barron's had an article about the Vanguard Global Capital Cycles Fund (VGPMX). I'm not really interested in the fund so much as an allocation implementation that is a holdover from when this fund used to be called the Vanguard Precious Metals and Mining Fund. 75% of the fund is in global value stocks with the remaining 25% in mining stocks which is a huge overweight to that industry.

The fund goes back further than 2019 but the current manager started in 2018, so the period here gives us a clean slate to look at. ACWI is the iShares All Country World Index ETF and XME is client holding SPDR Metal and Mining ETF. The result surprises me, I'd have guessed that 25% in miners would be a real drag on returns. 

VGPMX' outperformance looks like it can be attributed to the fund going up in 2022. It doesn't look different versus ACWI in 2019, 2020, 2021 or so far in 2024. Blending 25% in with ACWI helped in 2022 but otherwise it's not much different than 100% in ACWI. I really am surprised this doesn't create an easily observed differentiated return stream. XME fell 50% in 2015 and then made it all back with a 106% gain in 2016. That sort of volatility with a low-ish correlation has a place in a diversified portfolio but I think 25% is well past the point of diminished returns. 

And speaking of derivative income funds, a Twitter ad prompted me to circle back to the Defiance S&P 500 Income Target ETF (SPYT). I mentioned it in March when it first started trading. The differentiation to this one is it sells 0dte call spreads as an overlay to holding the S&P 500 and it targets a 20% annual yield. A little more specifically it sells a close to the money call option and buys a call with a higher strike price. For Monday, June 24 it is short a 15 point spread having sold a 5470 and bought a 5485. 

With covered call funds, gains are capped up to the strike price of the call that was sold. With SPYT, if the index has a huge rally, the fund could participate in gains above 5485 on Monday. 

The credit from selling that combo every day accrues for a monthly distribution. So far it has paid three dividends, totaling $1 which works out to about 5% so it's on track to get close to 20%. 

As is common to these, there is an obvious lag to market cap weighted S&P 500. You can add 5% back in for SPYT, Personal holding ISPY paid out three dividends totaling $0.98 since SPYT's inception which adds 2.3% in for its total return. XDTE is similar to ISPY but it sells options the morning they expire where ISPY sells options in the late afternoon the day before they expire and for that one you can add back 5% to get its total return.

Small allocations to this space seems reasonable for bringing in a little more yield to a portfolio but they consistently set the expectation that they will not keep up with the broad market. Having the correct expectations is very important for these. If the NAVs can compound positively, not all of them do, and they pay higher yields, that's pretty good but again, not all of the NAVs compound positively and maybe with enough time to study, we might see that none of them compound positively. 

Finally as a funny coincidence, while I had the tab open writing this post, I found an article at WSJ about derivative income funds and buffer funds. I don't write about the buffer funds. The short version from me is just don't. Really just don't with the 100% downside protection funds. The market isn't going to go down 100%. If you actually think the market could go down 100% you should sell now and not rely on the buffer funds to work. 

Of course I read the comments. Always read the comments. A lot of commenters were skeptical of the promise of higher returns with lower risk that these funds offer. I read the article twice and I didn't see where the article said that and of course they do not have higher returns with less risk. If the article says that and I missed it, so be it but they most certainly should not be expected to have higher returns with less risk. In theory, a sequence of returns could play out that way but with the derivative income funds I think anyone using them should expect lower returns, lower volatility and higher income. Not all will deliver on those expectations. With the Defiance put selling funds, the erosion is huge unless you reinvest the dividend. If the full dividend is reinvested then so far, they do have a positive total return.

JEPY is a good example with its so far limited time frame. There are no negative surprises in that screenshot. Even here though, it is important to understand that the underlying index is up a ton, it is up an amount that should not be counted on to repeat frequently. Occasionally, yes it will be up that much but not frequently. The few small dips along the way did not damage JEPY in real time and I believe the daily nature of the trades would help the fund avoid getting decimated in a serious decline. Before anyone adds 1+1 and gets 11, I would expect JEPY to go down plenty, just not get decimated like down 80% in a down 30% world but it might go down 40% in a down 30% world or maybe, if holders are lucky, it would go down less. I can see how it would go down a little less but I would not bet heavy on that outcome. 

The comments on the article that are suspicious of investment products are right but that doesn't mean they're not worth learning about. The comments about keeping it simple with plain vanilla equity exposure are right but that doesn't mean a blend heavily tilted to plain vanilla with a small allocation to a derivative income fund must be bad. 

It's only partials from two different years but that income profile might make sense for someone.

One point that the article did not make in talking about the risk to retirees of having too much in equities and then the market dropping a lot. I would argue you are far better off having a combination of cash, a holding or two that you are confident will go up when stocks drop and a holding or two that will trade like a horizontal line that tilts upward no matter what is going on. And if you don't believe in those last two then just have cash set aside. How much to set aside is up to the individual but I would keep in mind that typical bear markets range from 18-30 months. 

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