What To Make Of A 14% Yield In A 5% World

On Tuesday I sat in on a webinar for the Calamos Autocallable Income ETF (CAIE). Based on the webinar, autocallables are a longstanding and widely used institutional product packaged as a structured note that pays a high income and is usually tied to some sort of reference security, in this case a low volatility version of the S&P 500. CAIE purports to be the first product that makes autocallables available in an ETF so it avoids high minimums and makes it more liquid. 

The expected distribution yield should be close to 14%. The distribution will be characterized as a return of capital which makes it tax friendlier versus dividends. At one point they said the return/volatility profile will resemble put-writing but then later they said it will have a little more volatility than the S&P 500, maybe a 20 vol versus 16-18 for the S&P 500 they said. Their comments about put-writing and a 20 vol don't necessarily conflict, not saying that, but being a little more volatile than the S&P 500 paints a better picture. 

They said it is a diversified income stream when compared to traditional fixed income but the way they talked about derivative income funds (covered call fund) at the start, CAIE may not be diversified against covered call funds. There are strategic differences. The said that covered call funds are more sensitive to market drawdowns which makes sense and that autocallables have a level, 40% down for the reference index in the case of CAIE, where problems start to occur. They noted that 40% breaches have only occurred 3-4% of the time and they were mostly concentrated during the financial crisis where there were multiple months where the index was 40% below the high. Read the literature to get a better handle on this. 

This is a complex product and I am not yet at the point where I can really dissect what can go wrong. At a high level, I would take a 14% yield in a 5% world to mean there is a lot of risk. Understanding that point is pretty important. It's ok if something has a lot of risk in this context so long as any prospective investor realizes it, that could be like a first level filter. If I am interested in buying something, a second level filter would be understanding the idiosyncratic risks of the product or strategy. Catastrophe bonds are easier for me to understand for whatever reason, autocallables not yet, maybe not ever, who knows?

But if CAIE does turn out to be a little more volatile than the S&P 500 with the tradeoff being a 14% "yield," I can get 75-80% of that "yield" from catastrophe bonds with a small fraction of the volatility. Cat bonds have risk to be clear but the risks are much easier for me to frame out at this point. You can search the archive in the right sidebar to learn more about cat bonds. 

If I wanted to add $1400 of income to a $100,000 portfolio, would it make more sense to have a 10% allocation to CAIE or a 2.8% allocation to the YieldMax Amazon ETF (AMZY)? AMZY had a 50% "yield" in 2024 while dropping about 11% on a price basis (the return for the underlying was very good but AMZY couldn't keep up with the dividend). Interestingly, AMZY's total return wasn't that far away from the common.

If CAIE malfunctions in a way that at this point is beyond what we understand about it, causing it to cut in half, that is a 500 basis point hit to the portfolio arguably caused by chasing yield. If Amazon common cuts in half because there is a 30% drop in the S&P 500 (not unrealistic) how much would AMZY drop? At the April, 2025 low, AMZY was down the same 29% as the common stock but even if it dropped 75% versus a 50% drop for the common, there would be fewer dollars at risk, $2100 from AMZY versus $5000 from CAIE in my scenario.

My scenario of a 50% risk to CAIE might turn out to be very very wrong, maybe I will come to learn that in time but my first inclination about something with such a high yield is to assume it is very risky. The risk to something like AMZY or cat bonds is easier to frame out, for me anyway but if I learn differently about CAIE I will blog an update.

Roundhill will be launching an S&P 500 ETF that looks to avoid paying any dividends by selling stocks before their respective ex-dates and the proposed symbol is XDIV. If it goes as plans, it would be a more tax efficient way to access the index. The fee has a couple of moving parts but for now, with the fee waiver, XDIV should cost 0.0849%, 8.5 basis points, which wouldn't exceed the tax liability for people likely to be interested in this. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

Deconstructing Autocallables

Earlier this week, I spent some time trying to dig in more to autocallable ETFs with the help of Copilot. The basic idea is that autocallables have been around for a while as structured notes, an investment product, that tend to have high yields and last year, they started to become available via the ETF wrapper thus democratizing the product. 

We've looked a few times at the Calamos US Equity Autocallable Income ETF (CAIE). The very basic idea is that it pays 14% annually (it's a monthly pay) so long as the reference index does not decline 40%. If the decline is that big then payments are suspended until the underlying index recovers back above point where it breached 40% down. I remember from the presentation when CAIE first listed that there was only one instance where the index went down such that payments would have been suspended. 

CAIE owns 52 autocallables with one coming due and getting replaced in the fund every week which can reduce volatility some. 

It's not even a year yet but you can decide for yourself what you think about it. My hang up has been that I don't think I really understand the risk here. A 14% yield in a 4% world has risk. It's not that no one should take the risk but I don't believe in taking risks that I don't understand. I may have made progress with Copilot. It was kind of a long back and forth but it was productive and hopefully I can convey what I think I've learned. 

I'll include tables from Copilot but the TLDR is that although they continue to pay out as long as there is not a 40% decline, the price will be sensitive to price swings in the reference index which is a derivative of the S&P 500. 

This next one makes them seem very complex.

The prompt for me to do this was that GraniteShares launched autocallable ETFs for two stocks, one tracking Tesla with symbol TLV and the other tracking Nvidia with symbol ANV. I made the obvious observation awhile ago that this sort of thing would be coming and that it is something we should try to learn about. 

Copilot said the "structural mechanics" of TLV and ANV were the same as CAIE other than using individual names for the reference securities. It said the yield on TLV and ANV wouldn't be higher than CAIE. I pushed back on that because by definition there is more risk in a stock than an index so the compensation for the autocallable tracking stocks should more. 

First it agreed that you'd expect higher yields but...

What it really meant was that the yield will be a little higher with TLA and ANV but not enough to compensate for the volatility and risk of the underlyings.

Copilot thinks that TLA and ANV will "carry 2-4x the risk of CAIE but only offer 1.2x the yield of CAIE."

Hoo boy. So I asked if the GraniteShares concept would make more sense with less volatile names like maybe Microsoft and Alphabet. 

Using lower‑volatility stocks like Microsoft or Alphabet would make the GraniteShares autocallable concept materially better — but not for the reason most people assume.
It’s not just “lower vol = safer.”
It’s that autocallables behave non‑linearly with volatility, and MSFT/GOOGL sit in the sweet spot where the structure actually works as intended.

That's really quite an indictment of TLA and ANV. It goes on to say "bad tradeoff" describing TLA and ANV. Using MSFT and GOOG has volatility characteristics that would make the autocallable behave more like it's supposed to behave, it said. 

Alright, I guess Copilot is not a fan. We're going with the idea that Copilot is correct.

While I still am not so intrigued that I want to step into CAIE, knowing there is downside sensitivity helps me understand a little better. I am not saying Calamos said there would be no downside but I don't recall it being discussed.

The reality is that CAIE will "work" the vast majority of time but not feeling like you fully understand what can go wrong makes it a difficult hold even if we understand a little more than we did before. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

"Things I Think I Think"

There's an idea that if you can't argue the other side of what you believe, that you don't really understand what you think you believe. As a dumb example, I am a lifelong Celtics fan. Are the Celtics the greatest team ever or is it the Lakers? I think I can make the argument for the Lakers despite believing the Celtics are the greatest team of all time. 

Sort of related, Cullen Roche regularly blogs 3 Things I Think I Think which is an outlet for him to challenge his beliefs. 

On Friday, I listened to the Trillions podcast. Matt Kaufman from Calamos was the guest and the primary topic was the Calamos Autocallable ETF (CAIE). I wrote about CAIE a couple of times and those posts were some combo of being skeptical and negative. So far though, the fund has done very well. Despite paying out just over 1%/mo, the price has mostly kept up with the S&P 500. 

The product is complex. Listen to the podcast to hear Matt explain things but basically, the S&P 500, as the underlying reference security would need to fall 40% for there to be problems. That doesn't happen very often.

The S&P 500 is the reference security but CAIE targets a volatility that is about double the S&P 500. That sounds scary but the fund is comprised of 52 different autocallables such that one matures every week and get replaced by one maturing later. 

The distributions are allowed to be taxed as return of capital. You'll find differing opinions on that but I think it is a positive. The distributions lower your cost basis so there will likely be capital gains tax due when shares of CAIE are sold. 

I have a theory about how CAIE can keep up with the S&P 500 on a price basis despite having a large distribution. The higher volatility (which I am saying is essentially 2X leverage) allows one X to be the price appreciation and the other X to be the distribution. This does create a path to drawdowns being larger which you can see in a couple of instances on the chart. If the S&P 500 drops 40% from when CAIE was priced (if I understood Matt correctly) the distributions will be suspended until the S&P 500 gets back above the 40% decline line. 

Many times before, I said something like if a product yields 8% in a 4% world, there is some element of risk. That isn't necessarily a bad thing but I think you need to understand the risk you're taking.

I don't own CAIE anywhere. To be direct about it, I do not yet understand the risk, I'm not sure what can go wrong beyond the 40% decline suspending the distributions. If the S&P 500 falls 25% and lingers down there for an extended period, I would expect CAIE's price to fall a lot but the distributions would continue to flow. There might be counterparty risk with JP Morgan who is on the other side of the autocallables.

This is worth learning about, I may never connect on this, we'll see but these are interesting to me intellectually if nothing else which is a challenge to how I view complex products. 

The expectation I would have is equity volatility with a lot of "yield." While it has only been a few months, I am intrigued by the idea that it may have solved the erosion problem that derivative income funds tend to have. 

Here's some crazy portfolio ideas I played around with that are relevant to this post.

Whether these are great or whether they stink, they're pretty close to VBAIX but don't do any favors with respect to volatility. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

Derivative Income Disaster

Today's ETF disaster comes from Coinbase. Disaster might be too strong of a word but below is the GraniteShares Coinbase Yield BOOST ETF (COYY) and the underlying common. 

It may not be as bad as it seems. It is a weekly pay and so far, all the distributions add up to $8.75 which is a little better than a 33% "yield" from the August price in about three months. It should be pointed out that the distributions have also been trending lower along with the share price. On a total return basis, COYY is only a couple of percentage points behind the common. 

This chart compares the Nvidia Yield BOOST and the common.

The common up huge for just a few months and the price only chart for NVYY is still down double digits. It's not that these are malfunctioning in any way, I don't think they are, the point is how difficult these probably are to hold. I do think that as part of some sort of draw down strategy, a small slice can be useful with the right expectation. These are going to erode down to almost zero and then reverse split. Growth from the part of the portfolio that is some sort of normal equity exposure should more than offset any erosion from a very small slice someone allocates to a crazy high yielder. That will probably not be compelling to too many investors though.

Calamos is coming out with another autocallable ETF that will have symbol CAIQ and be tied to the NASDAQ. Eric Balchunas Tweeted that it will target a distribution rate of 18%. 

These are billed as not having a problem with erosion like the crazy high yielders. Looking at the chart I would say erosion has in fact not been an issue for CAIE but even if you agree with me on that, I would not say the science is yet settled on this point. 

The product in the ETF wrapper is a democratization of a a structured product that is usually only available to institutions. CAIE's distributions would be disrupted by a 40% decline the the S&P 500. I couldn't find the similar pivot point for CAIQ but some sort of hideous decline in the NASDAQ and CAIQ's distributions would be suspended too. 

I don't think the risk is so much a decline of the magnitude that would cause distributions to suspended because of how rare they are. It is not clear to me whether the market price of the ETF might deviate from the NAV of the autocallables held by the funds if the underlying index fell 25%. Assuming no malfunction or something breaking, a 20% decline for the reference index doesn't impact the underlying holdings, the actual autocallables. 

A key point in that last paragraph; "assuming no malfunction or something breaking." Anything that yields 14% like CAIE or 18% like CAIQ in a 4% world carries risk. Maybe you can figure the risk out and then you can make an informed decision as to whether the compensation is adequate for the risk taken. It is difficult for me at this point to think the only risk that the index falls 40% in a short period of time and that's it. 

A small slice to an autocallable ETF wouldn't be ruinous if it malfunctioned. There are several unrelated niches that have very high yields and could be added to a diversified portfolio to meaningfully enhance the yield. A meltdown in the autocallable market would have nothing to do with catastrophe bonds or a bank loan fund. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

Autocallable Theory

Larry Swedroe did a deep dive on the Calamos US Equity Autocallable Income ETF (CAIE). The basic idea with the fund is that it owns a series of structured notes that mature each week. The fund targets a 14% distribution. The fund would run into serious problems if it's reference index fell 40%. The reference index is similar to the S&P 500. CAIE has sensitivity to the reference index on the way down but in its one test so far, it captured a lot less of the reference index' recovery which is to be expected based on the structure of autocallables. 

You might look at that and decide right away these aren't for you (XV, SBAR and ACYN are also autocallable funds) but there has been no malfunction with them. 

Some points made by Swedroe; first is that 90% of the distribution is a return of capital. Yes it is a very high percentage. He warns that this has the effect of lowering your cost basis in a taxable account so that when/if you sell the cost basis might be nothing, so you'd owe a capital gains tax. Yes but that would be less than the tax on a true dividend. 

Larry then talks about gains being capped as I noted above which is correct. Don't buy this looking for an equity proxy on the upside. Larry notes the 40% threshold for problems starting, that is called a barrier, and yes a decline that big would be bad for the fund but it would be bad for everything. Don't buy this looking for downside protection. He further equates it to being short a put option which gives some good context for how it should behave.

The next issue is the counter party risk with JP Morgan and the cost embedded to pay the counter party. This isn't quite the threat he makes it out to be, if you don't already know this, don't bet too much of your portfolio on the credit worthiness of one bank. The odds of things ending badly for JP Morgan are quite low but sized correctly the actual risk is minimal.

He picks at the complexity and opacity. Yes, they are both, moreso complex than opaque. The strategy is learnable, I'd argue that these funds are less complex than the typical macro fund. Yes it is not cheap too. This is not a three basis point index fund. 

Larry says the NAV must erode and you can see that with SBAR and XV but it hasn't happened yet with CAIE. It probably will erode but I am always leery of using the word must. 

The article finished with checklist of sorts, what you want versus what you get. Once you understand what the fund does you realize that if you want what Larry says you want, you should find a different strategy.

As a matter of curiosity, I'm always going to want to try to find a plausible use for these flawed products, products riddled with drawbacks anyway. I continue to believe there is a use case for things like autocallables and crazy high yielders as part of bridge to the next financial milestone like taking Social Security or taking RMDs with the expectation that any basket of these will deplete toward zero.

The question/tradeoff goes something like this. An investor is 62 and wants to live off a $200,000 bucket of money until they take SS at their preferred age of 68. The income need from this piece of money is $40,000/yr for six years. If they leave the $200,000 in cash they can get five years, plus a couple of months from the interest. How likely would it be to squeeze out a sixth year or even a 7th thanks to the large distributions (ROC and all).

Using a combo of autocallables, not the craziest high yielding YieldMax funds (think Microsoft and Google, not Tesla and Microstrategy), cat bonds, then a sleeve in something like the BCKT or LDDR ETF which both offer depletion strategies and I threw in WTPI which is a pretty high, not crazy high, yielding  ETF that sells put options and doesn't really erode, it doesn't go up on a price basis but it hasn't eroded. There are countless closed end funds that could be part of the discussion to. 

With enough holdings, like maybe a dozen, any sort of issuer risk, strategy risk or idiosyncratic risk could be reasonably diversified.

Back to our $200,000 example, taking $40,000/yr from a basket of these would leave $57,000 left over after six years and probably get the investor through a 7th year with just a little leftover.

If it works out that a lot or most of the "yield" is ROC, that would not count toward modified adjusted income which could keep someone below the income threshold for health insurance from the marketplace to be subsidized which would be helpful until Medicare starts.

There are several grains of salt to take here related to reduced distributions and an extended downturn in markets but to the extent we do some work here on portfolio theory, this one is pretty far out there but still interesting. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation. 

This Post Will Melt Your Laptop

There was a quick mention in the Streetwise column in Barron's about the strong year that the iShares Convertible Bond ETF (ICVT) is having. 

CWB is the SPDR equivalent fund. Clearly, they are both having strong years so this is a good opportunity to reiterate from a few previous posts that convertible bonds, as opposed to convertible arbitrage which is a different strategy than just buying convertible bonds, don't really trade like bonds. Convertible bonds have equity-like volatility. There has been a history of performance differentiation from the S&P 500 which might be interesting but the point is convertible bonds don't really look like what most people expect bonds to look like. If stocks get hit for whatever reason, I would not rely on convertibles to offer real defensive attributes.  

Here's the same grouping from 2022.

In both charts, ICVT and the S&P 500 look pretty similar. Here's the differentiation I was talking about, year by year.

Here are the top issuers in ICVT.

CWB reports by issues held not issuers. 

Although not in the top ten, CWB holds the MicroStrategy converts, other crypto related converts, AI and meme company issues, pretty much just like ICVT. So there is quite a bit of heat under the hood of these funds. That isn't on its face bad by any means. 

While I've been clear I want no part of Strategy, realistically a three-ish percent weighting in a fund that if anything would get a small portfolio weight probably isn't big enough to move the portfolio needle if something terrible happens to Strategy. If the entire crypto space blows up then these funds would probably feel it and if somehow, crypto, memes and AI all got badly damaged at the same time then I would guess ICVT and CWB would both go down a lot. That's not a prediction, it's simply an understanding of the holdings and an attempt to assess the risk. If part of the reason all three (crypto, memes and AI) are doing well is because of the same excesses and then there is a consequence for that excess then all three would probably go down a lot, impacting ICVT and CWB. I'm really hitting on this point not as a prediction but a risk study.

We've looked at the Calamos Autocallable Income ETF (CAIE) a couple of times since it listed. It's a complex product with a high yield that was expected to be a little more volatile than the S&P 500 which is its reference security. 

It seems to be doing what it said it would in terms of volatility including a 3.21% decline on Friday. It has paid out $1 in distributions (ROC) since it listed on its way to what they say should be a 14% annual "yield." You can click above to get a little more detail but part of the story here is that bad things happen to CAIE if the S&P 500 hits a 40% decline/barrier. Obviously that is a very rare thing but in terms of framing one of the risks, that is one to learn about. 

Autocallables are an institutional strategy that is usually wrapped in structured products so CAIE is an attempt to democratize access. GraniteShares filed to issue autocallable ETFs for 20 individual stocks.

There's a lot of heat on that list, I will not be responsible if your laptop melts from looking at that image for too long. GraniteShares of course has a lot of derivative income funds including the YieldBOOST suite which sells puts on 2x levered ETFs. Some sort of comparison between covered call funds and autocallable funds will be a fun exercise if we ever get the chance. Here's the filing. 

At this point, I think that the performance of the underlying reference security is more of a determining factor for autocallables than products like YieldMax covered call funds and I think the manner is which the two harness/exploit volatility is a little different as well which if correct could be a useful point of differentiation for someone managing a drawdown portfolio and is hell bent for yield.

That's just an impression, it is way too early to know whether that is correct or not. 

We got back safe and sound from Maui early Friday just ahead of what might be the start of the air traffic controller callout impacting the Phoenix airport. I don't know what the reality or magnitude of the callout is but if the story is real, then we got lucky. I've been taking pictures of this same truck for ten years. My wife asked if we were going to visit "your truck."

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

ETF Slop

That phrase, ETF slop, was the focal point of an episode of the Rational Reminder podcast. It's a long one but the key point was to question whether newer ETFs actually benefit customers or not. Things like crazy high yielders and 2x single stock ETFs would be part of the ETF slop discussion. 

I'm willing to learn about any ETF or strategy, slop or not. If you read these posts regularly, you probably know what sorts of things I think of as being slop, like the two above, but I think it is time well spent trying to challenge my belief of what is slop or the other way around, study ETFs that maybe people would not consider slop but actually is.

There are some derivative income funds that offer utility without "yielding" 80% and I believe in the idea of capital efficiency even though I am very skeptical about bundling it into an ETF. There are quite a few levered equity/managed futures products either coming or recently listed. Simplify just listed one with symbol CTAP and I believe Man Financial and JP Morgan each have one coming if they're not out already. The capital efficient (levered) space is going to proliferate. 

I believe PIMCO is the first in the space with its Stocks PLUS Long Duration (PSLDX) which is 100% equities/100% long bonds. PIMCO just launched something similar in an ETF wrapper. SPLS looks like 100% equities/100% various PIMCO bond funds. 

Are any of these for the customer's benefit or are they just slop. It depends who you ask but I would encourage skepticism when assessing complex funds. 

Reading the description of SPLS, it almost reads like it is stocks plus carry. It certainly does not appear to be stocks plus duration. Carry can be several different things. It can refer to long backwardation/short contango, it can also refer to the income stream kicked off by a investment like a dividend from a stock or a coupon from a bond. RSSY from ReturnStacked does both.  

While no one suggests putting the entire equity allocation into RSSY, I have no idea why someone would want to own it. But that doesn't mean there isn't something to the idea of stocks plus some version of carry. Stretching beyond the typical definition of carry, the description of SPLS got me wondering about adding arbitrage on top of equities. SPLS seems to want to add fixed income yield on top of stocks without a lot of fixed income volatility and maybe that will work but arbitrage is usually a very low vol, absolute sort of return strategy.

Portfolio 3 might replicate what SPLS is trying to do but I believe SPLS will be active in owning different PIMCO fixed income fund but that model was down 35% in 2022. These are clearly no picnic where it comes to volatility and drawdowns. Portfolio 1 was surprisingly volatile and was down more than just the S&P 500 to varying degrees in 2002, 2008 and 2022. 

There's certainly no magic bullet with this idea but it's time I will continue to spend. 

Closing out, we knew these were coming at some point. GraniteShares filed for a single stock autocallable ETF on Robinhood. CAIE from Calamos has been wildly successful in terms of AUM and having a very high yield but without an eroding NAV. A very high level on how these work is they pay out very high yields unless there's some sort of very large, predetermined decline in the underlying security. CAIE yields 14%. I didn't see any mention of the yield in the GraniteShares filing but if you figure we are in a 4% world then one way or another, getting a 14% yield means you're taking a lot of risk. That's not a bad thing so long as you understand the risk being taken. A diversified portfolio includes holdings with various risk profiles, that really is not problematic when sized correctly. 

For now though, I do not have the risk to autocallables dialed in. I'll get there but for now, it's hard to figure that nothing bad happens with CAIE until the S&P 500 drops 40%.

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation. 

What If There Is A 'Never Happened Before' Volatility Event?

In case I haven't stated it plainly, I think there is a lot of value in looking at other people's strategies and ideas for asset allocation and then building their idea with holdings you think would work better. 

We've looked at Cambria Global Asset Allocation ETF (GAA) which is 45% equities, 45% fixed income and 10% alts as well as Cambria Trinity (TRTY) is which 35% trend, 25% equities, 25% fixed income and 15% alternatives in this context several times. TRTY seems quadrant inspired to me. GAA has compounded at 5.98% since its inception in 2014 while price inflation has run at 2.99 and VBAIX clocked in at 9.01%. TRTY has compounded at 4.90% since its inception in 2018 while inflation has run at 3.63% and VBAIX compounded at 9.63%.

Both GAA and TRTY might be having their best years in 2025. GAA is up 14% YTD, it's had two years in the past where it was up 15% so I am extrapolating to say this might be it's best year. TRTY is up 11%, it had one year it was up 15% so it's a coin flip at this point whether 2025 is its best year. 

The homemade GAA in Portfolio 2 certainly has worked and done far better than GAA. Same for the homemade TRTY below.

Using three or four funds is fine for blogging expediency but not something I would do IRL. And as we've talked about in previous posts, I wouldn't go anywhere near that heavy into managed futures, cat bonds or a single alternative strategy. 

Pivot to the Rational Reminder Podcast crapping all over covered call ETFs. I'm unfamiliar with these guys, Meb Faber Tweeted the link to their podcast. It's a pretty thorough take down. Their starting point is that dividend investing is fine, suboptimal but ok, they are total return guys as am I for the most part. A diversified portfolio that goes narrower than a broad based index fund should include the attributes that dividend payors typically offer. 

At the other end of their spectrum, the podcast guys put single stock covered call ETFs. The risk return tradeoff of capped upside with all the downside is a bad tradeoff as they see it. At about the 20:35 market though, one of them sort of makes the point we make here about them. They say that if someone is trying to exploit volatility, that maybe derivative income funds aren't so bad. They quickly noted that the fund providers are not marketing them that way and that they don't believe individual investors are trying to do that either. The first point is definitely true and the second one is probably true. 

A few weeks ago or more I stumbled into framing all the derivative income funds as absolutely not being proxies for the underlying reference securities. The context in the Rational Reminder Podcast seemed to try to tie them to the reference security except at the 20:35 mark, where they talk about exploiting the volatility. I think that is close to how our conversation about them has evolved. The derivative income funds combine the reference security and the volatility of the reference security. NVDY and NVYY shouldn't be expected to track Nvidia, they combine Nvidia and selling the volatility of Nvidia which is a different thing. 

If you have an interest in any of these, once you let go of them tracking the underlying and accept they combine the underlying and the volatility of the underlying then I would say you're exploiting the volatility. The next level then would be whether you're exploiting it in an effective manner or maybe better put, a closer to optimal way. 

This popped up on Twitter on Friday.

In the replies, someone noted that CAIE sells volatility and tail risk. It is certainly doing well in nominal terms right out of the blocks. In July I said that 14% in a 5% world clearly has risk regardless of whether we can figure out what the risk is. CAIE is complex and anyone buying it needs to realize that and I would encourage making sure you can wrap your head around what the risk is. To the extent it sells volatility and tail risk (great way to frame it), owning CAIE, one of the crazy high yielders and something like JEPI all take different variations of the same risk. There may never be a consequence for loading up on all of these but the risk is still there. Splitting 10% between a bunch of these types of strategies may not constitute loading up but if some sort of never happened before volatility event occurs, I would expect all of them to get hit to varying degrees. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

Factoring Expectations

Whenever we've talked about factor funds like momentum, buybacks or maybe something dividend related I usually say something along the lines of if you're going to pick a factor, it is very important that you stick with it for a long time. The odds of getting into a factor that has done well of late only to see it then struggle are high in a Murphy's Law sort of way. But if it is a valid factor, it will have its time in the sun. If there is any value to factor investing it is that it works longer term. Anything else and the result is likely just continually chasing the factor that was hot last year. This behavior will lead to underperforming. 

In selecting a factor other than market cap weighting, I think there needs to be some reasonable basis to believe it will differentiate. For example, based on how it has performed since inception, I don't know why anyone would choose the iShares Quality Factor ETF (QUAL). It looks identical to the S&P 500.

It's not the quality factor itself, it's the fund. There are other quality factor funds that don't track as closely as QUAL. 

I had the above thought about factors as I read this from Jeff Ptak about the difference between fund performance and the return that investors actually get from those funds. The difference or "gap" is not about the funds, it's about investor behavior like buying JEPI after its great 2022 only to sell it at the end of 2023 because it lagged by a mile. You could apply that example to managed futures funds. Jeff looked at several alt categories and the gap varied depending on the fund but other than precious metals funds, investors generally underperformed the funds they held due to poor timing buying and selling. 

The problem isn't the funds, it's investor behavior that causes the issue. For this article, Jeff looked at funds that...

...utilize approaches that aren’t tethered to the broad stock and bond markets. These types of funds boast high diversification potential and thus, in theory, could nicely complement one’s primary stock and bond allocations. But because they’re idiosyncratic, it’s also possible they could push investors’ buttons, nullifying whatever diversification benefits they might confer.

Dialing it in a little more precisely, I think this is about having the wrong expectation. "High diversification potential" means won't look like the stock market. Client/personal holding BTAL is a great example. It is reliably, negatively correlated to the stock market. There's no other reason to buy it other than for that attribute. If it's doing well, chances are everything else is doing poorly. You want BTAL to do poorly but watching it do poorly can lead to giving up right before you might need it again. Managed futures is another example. It can do well when stocks are going up but it goes long stretches of languishing when stocks are going up. Watching managed futures do poorly can lead to giving up right before you might need it again, repeated for emphasis. 

Investors might think they want this;

But it means living through this;

The blue line portfolio will get the job done but it will differentiate which means it will occasionally lag behind a more traditional 60/40 which is a breeding ground for impatience and giving up at exactly the wrong time. 

One nit to pick from Jeff's article is that with the correct expectations, I don't think buying at the wrong time is that big of an issue. Whether you buy something like BTAL when it's up a lot like in April of this year or now when it is down, going forward it is very likely to continue to be negatively correlated to equities. Regardless of when it is bought, if the next 20% for the S&P 500 is up, then BTAL should be expected to drop and if the next 20% for the S&P 500 is down, then I would expect BTAL to go up. 

A week or two ago we looked at the latest autocallable ETF and the performance thus far of the first one. Both are from Calamos with symbols CAIQ and CAIE respectively. A commenter noted that because of what the index underlying CAIE actually tracks, that the fund got much closer to having the distribution suspended. Down 40% and the payouts stop until it gets back above the down 40 mark. I replied that I was probably being sloppy in saying the S&P 500 when the actual index isn't quite the S&P 500, it is the Merqube US Large-Cap Vol Advantage Autocallable Index which is close but not exact. 

Today I took a look and maybe I don't get it yet but I don't think it got anywhere near the point where distributions would be suspended.

Here's the link to the Merqube site if you want to dig in closer. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

Getting The Bond Effect Without Bonds

Morningstar has a writeup about interval funds that led me down a little bit of a rabbit hole looking at a couple of interval funds that focus on infrastructure. I found three of them via Intervalfundtracker. I would guess there are more than three but that's what they had.

• Meketa Infrastructure Fund (MAFIX)
• Cantor Fitzgerald Infrastructure Fund (CAFIX)
• Stepstone Private Infrastructure Fund (STDUX)

Interval funds usually have a mutual fund-like symbol but they cannot be sold anytime you want. Usually there is a limit to how much of the fund can be redeemed so if you had to get out for some reason, it could take a long time.

The link in the name of two of the funds above goes to a schedule of holdings. I couldn't find one for CAFIX. MAFIX is supposed to have 80% in private investments, 10% in cash and 10% in publicly traded securities but it looks like the weightings to cash and public companies is higher than the stated targets. The Stepstone fund appears to be all private holdings. 

IFRA has been much more volatile than the others and IGF obviously has been the best performer. If an infrastructure fund owns a lot of utilities as some do, it will be less volatile and if it owns a lot of industrial stocks it should be expected to be more volatile. If CAFIX targets more utilities then the modest return with less volatility is what should be expected or we could be seeing the result of infrequent marking to market or as Cliff Asness calls it, volatility laundering. Utilities are the largest sector in IFRA but industrials, materials and energy add up to more. 

It is my nature to want to learn about this stuff. The ETFs are competitive with the interval funds, so far. That could change, If you think the managers of the interval funds might know what they are doing then we might be able to learn something new about portfolio construction even with delayed reporting. 

Speaking of things that are worth learning about even if you never use them, Calamos just launched an Autocallable Income ETF (CAIE). It appears that it is somewhere in the defined outcome/buffer/derivative income fund realm. The literature refers to it being like a structured product. I signed up for a webinar to learn more but it purports to have income and low volatility. Based on reading what is available, it makes it seem like it could be similar to catastrophe bonds.

Finally, as we look at getting the bond effect without bonds, I wanted to revisit the Innovator Defined Wealth Shield ETF (BALT) which is a buffer fund. During the April panic, I blogged about whether BALT was malfunctioning. I got feedback on Twitter that it should square up at the end of the quarter. I'm not sure if it squared up or just got lucky in the market but the April drop has been recovered. The decline was very modest but more than someone might expect at 3.4% per Yahoo. 

I am a hard no on using buffer funds for equity exposure but there is something to them, BALT anyway, as a fixed income substitute. 

Using BALT instead of AGG has given a higher compounded return with less volatility. The outperformance isn't solely because of 2022, VOO/BALT outperformed in partial year, 2021, 2023 and 2024. This year it is trailing a little bit.

The volatility of BALT seems similar to SHRIX but obviously SHRIX which is catastrophe bonds has outperformed considerably. That big drop in SHRIX in late 2022 was from the threat of Hurricane Ian but it turned out there was no triggering event from that one. I threw in XYLD which is a long standing covered call fund. I don't think that one works in the context of a bond substitute. It looks like bonds on the way up but it looks like stocks on the way down. The 3.4% drop for BALT appears to me to be it's largest drop and as Dennis Eckersly would say when he was calling Red Sox games, AGG goes down 3.4% "just to stay in shape."

This last backtest has interesting results. As great as I think catastrophe bonds are, I wouldn't put anywhere near 40% in them IRL. I wouldn't put anywhere near 20%. The point is that BALT and SHRIX are just two examples that could be blended in with others that have similar attributes and maybe CAIE will too, we'll see. Having four of these that have different risk factors, weighted at 10% each seems like a reasonable risk. 

I don't use BALT and I am unlikely to do so but the exercise of looking for a different effect than the stated objective is worthwhile.

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

Has The Decline Hurt Autocallables?

We've looked several times at the burgeoning autocallable product space. Generally, these are structured products tied to reference security that pay out very high yields like low to mid teens, not the crazy high "yields" of 40-50% from derivative income funds. Accessing them through an ETF is relatively new.

The Calamos fund (CAIE) is the first one we looked at.

Nothing has malfunctioned so that's good. What we're seeing first hand instead of theory from a marketing sheet or from AI is that there is a sensitivity to falling equity prices. 

This next one references Nvidia.

ANV so far has been pretty smooth and you'd add back about 100 basis points in for the distributions paid out so far. However normal or not the market's volatility has been for the last month, ANV doesn't seem to be bothered by it.

Similar story with TLA which references Tesla.

The common stock has been a little less noisy over the last month, we can see a little downside sensitivity but again add 100 basis points back in for the distributions.

I'm still trying to wrap my head around the risks to this structure. They yield about 14% in a 4% world so there is risk. Taking risk you don't understand is something to avoid. 

Our next follow up is the Cambria Endowment Style ETF (ENDW). The fund is almost a year old and started out as a 351 exchange. As the name implies, it is a multi asset strategy. I take from the word endowment that it seeks to be all-weather to some extent but fair enough if that is not correct. 

The CAGR numbers are so high because ENDW launched one day after the Tariff Panic bottom but still, on a relative basis, ENDW has done well thus far. The ENDW fund page doesn't have pie chart info about the asset allocation.

Copilot did the math. ENDW runs with 30-50% leverage. The split between domestic and foreign equity is pretty close to evenly split. Let's play around with it a little to see how it might have worked longer term.

The results aren't much of a surprise. 

It makes sense that the leveraged version outperformed the unleveraged version but with a little more volatility. The only difference to Portfolio 3 is swapping out the ten year treasury exposure which reiterates a point we made yesterday that sometimes what you avoid is just as important as what you include. 

A final comment, I sent a note out to clients after the close on Tuesday noting the extent to which Tuesday's huge move looks like panic buying. I don't know whether stocks will drop tomorrow or the next day or not at all but I wanted to prepare clients for the possibility having seen these sorts of days happen many times before. Overnight futures are flat as I publish this post so maybe it won't give this gain back but I would be emotionally ready for that, repeated for emphasis, to avoid being caught off guard. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

The Emotional Cost Of Being Different

Let's check in on convertible bonds.

CANQ uses leverage to own a portfolio of fixed income securities with an overlay of equity options that is intended to create the effect of owning convertible bonds. You can see CANQ yields about 5.5%. CHI is a closed end fund that kicks off a lot of yield but the drawdowns in the price only version are brutal. CHI is less a proxy for converts than it is a yield machine. It fell 30% during the taper tantrum and last month it was down twice as much as the S&P 500. In the period studied, the State Street Convertible Bond ETF (CWB) is up 18% with less volatility than the S&P 500. Despite being "bonds," convertibles have a lot of equity beta. This was just a follow up on CANQ, it's done well. A fine return and the drawdowns haven't been catastrophic. 

The other day we had some fun looking at the cost of being different and some work from ReturnStacked. They came up with an allocation that they thought was optimal and actually useable after first discussing an allocation that is optimal but not really useable. 

I simulated Optimal Stack w/NTSX from the above linked post using SPY and AGG to go back just a little further. The red line portfolio is similar to optimal but not useable from the ReturnStacked paper in that no one would actually want to use it. It would be too difficult emotionally for many people.

It is a steady eddy but it lags almost constantly. It has been effective though at chopping off the left tail. Negative, outlying returns are referred to as being left tail on a bell curve, the portfolio we're talking about chops off the left tail because it looks different and the cost of being different is that it lags to the upside. Over the long term, I am quite certain it will provide an adequate long term result but I am also confident it would lag up markets most of the time. 

Simplify tweeted about its SBAR ETF and referred to it as an autocallable. XV which is another high yielding fund from Simplify is also an autocallable strategy. In case I am not the last to know, there you go. CAIE was generally considered the first autocallable ETF, I thought it was anyway, but SBAR and XV are a little older. Copilot said that the funds have always been autocallables but now the category/strategy is more recognizable so Simplify is referring to them as such.

A high yield with no NAV erosion is a good outcome but the market hasn't really been tested since SBAR and XV started trading. There is some sensitivity to declines as seen in March of this year. I threw BALT in there because there is some overlap of risk. I didn't throw in any crazy high yielders which has more risk overlap but as we know from many other posts, there has been plenty of NAV erosion with those products. I'd like to see how these weather a serious decline and then how quickly they can recover but a small allocation, like 5% of the fixed income sleeve, isn't reckless. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.