Is The 13% Yield From SLVO 'Fool's Silver'?

| About: Credit Suisse (SLVO)


SLVO's stock price has fallen by nearly half since inception nearly three years ago.

Has SLVO provided downside protection compared to SLV?

Has SLVO provided high monthly income to unitholders?


The Credit Suisse Silver Shares Covered Call ETN (NASDAQ:SLVO), launched on Apr. 16, 2013, is linked to the return of the Credit Suisse NASDAQ Silver FLOWS 106 Index. The Index seeks to implement a "covered call" investment strategy by maintaining a notional long position in shares of the iShares Silver Trust ETF (NYSEARCA:SLV) while notionally selling monthly out-of-the-money call options on that position. According to Credit Suisse:

The strategy is designed to generate monthly cash flow in exchange for giving up any gains beyond the strike price. The strategy provides no protection from losses resulting from a decline in the value of the SLV shares beyond the notional call premium.

Basically, SLVO sells call options on SLV to generate additional monthly income, but sacrifices gains if SLV appreciates above the strike price on expiration day. The workings of SLVO has been comprehensively described in a recent article by Maks Financial Services, and hence will not be rehashed here.

The below chart, obtained from SLVO's factsheet, nicely summarizes the mechanics of the fund.

(Source: Credit Suisse)

A previous article entitled: "Nearly 3 Years On, Has GLDI Delivered As Promised?" analyzed whether a related product for gold, the Credit Suisse X-Links Gold Shares Covered Call ETN (NASDAQ:GLDI), has performed up to investors' expectations so far. The analysis found that GLDI has indeed provided downside protection compared to an equivalent long position in the SPDR Gold Trust ETF (NYSEARCA:GLD), and that GLDI has succeeded in providing high, albeit lumpy income to its unitholders. However, the main drawback of GLDI was that it significantly lagged GLD during sharp gold rallies.

In the comment stream of that article, a number of readers asked me to perform a similar analysis for SLVO. Nearly 3 years on, has SLVO performed as advertised?

  1. Does SLVO provide downside protection?

In previous articles on this strategy, there appears to be some confusion among investors about whether SLVO does, or is even intended to, provide downside protection compared to SLV. For example, Stevlg writes (emphasis mine, edited for punctuation):

Just ran a perf chart (stock on the charts including SLV, GLD, CEF, SLVO, GLDI, SPY, using SPY as a base for ref. & it seemed to show little diff. in the downsides. Oh well.

If we look at the price-only chart since the inception of SLVO (Apr. 2013), then SLVO has clearly underperformed the underlying SLV. While SLV has fallen by -41.5% over the past 3 years, the price of SLVO has declined by -53.2%.

SLVO Chart

SLVO data by YCharts

When considering total return, which takes distributions into account, SLVO appears to have fared a bit better (-46.6%), but has still lagged SLV (-41.5%) over this time frame.

SLVO Total Return Price Chart

SLVO Total Return Price data by YCharts

Strangely, the above result is opposite to what was observed for the GLDI/GLD pair. As I described in my previous article, the (nearly) 3-year total return of GLDI (-30.9%) was superior to that for GLD (-36.6%), indicating that GLDI successfully provided downside protection compared to GLD. For the SLVO/SLV pair, however, SLVO appears to have even exacerbated the decline in the underlying SLV.

Using Dividend Channel's DRIP Return Calculator allows us to compare SLVO's results with and without dividend reinvestment. With dividends reinvested, SLVO's total return since inception is -35.00%, while without dividend reinvestment, SLVO's total return is -29.51%. The lower total return of SLVO when dividends are reinvested can be explained by the continually declining value of the security, which acts to decrease the value of reinvested shares. On the other hand, the value of cash that is not reinvested is agnostic to the underlying share price.

Click to enlarge

Interestingly, this data contradicts the total return data from YCharts shown earlier. Both with (-35.00%) or without (-29.51%) dividend reinvestment, SLVO has outperformed SLV (-41.22%). While some differences in performance figures from different sources might be expected, such a large disparity between the total return of SLVO from Dividend Channel (-35.00% to -29.51%) compared with YCharts (-46.6%) is surprising.

I therefore turned to a third source: InvestSpy. According to this data, the performance of SLVO since inception has been -34.1% compared to -36.8% for SLV over this same time frame.

Thus, I am inclined to believe that the YCharts data is suspect and that SLVO has, indeed, provided downside protection compared to SLV. This is entirely expected because the covered call strategy is essentially a defensive strategy that trades upside potential for immediate income. The only way (that I could think of) that a covered call strategy could underperform during a bear market is if there are sharp but brief rallies in the price of the underlying that may induce losses when the calls have to be repurchased.

Final confirmation came from a plot of the SLVO:SLV pair which shows a gradual uptrend over the past three years.

Click to enlarge

Lesson learned: YCharts total return data may not be accurate!

However, although SLVO has outperformed SLV over the past few years, it does sacrifice gains when silver appreciates quickly in value. During a brief but sharp silver rally in August of 2013, SLV appreciated by 24.10% in less than 1 month. However, SLVO lagged behind, with a gain of only 8.19% over the same time period.

SLVO Total Return Price Chart

SLVO Total Return Price data by YCharts

Where the rise in silver is not as swift, SLVO can keep pace with SLV. For example, SLV increased by 13.72% from late August to mid-October in 2015, for a gain of around 8% per month. Since this is only slightly higher than the 6% out-of-the-money calls that SLVO sells, the fund would not be expected to suffer great losses in buying back in its calls before expiration. Hence, the total return of SLVO over this time period (+12.38%) was only slightly less than that of SLV (+13.72%).

SLVO Total Return Price Chart

SLVO Total Return Price data by YCharts

  1. Has SLVO provided monthly cashflow to its unitholders?

In the graph below obtained from SLVO's factsheet, we can see that the index has paid out impressive monthly distribution to its unitholders. The annualized distribution percentage is calculated by dividing the premium received by the Index by the Index level on the business day preceding the distribution. Due to variability in call income (which depends greatly on volatility in the underlying GLD shares), this monthly distribution is not smooth but is instead extremely lumpy. Some months have paid out in excess of 30% annualized distributions, while others are as low as 5%.

Plotting the actual dollar values of the dividends received, however, tells a slightly different story.

The graph above reveals that the monthly distributions paid out by SLVO have been steadily decreasing over time. For example, the first 12 months of distributions totaled $2.70, whereas the most recent 12 months of distributions summed to $1.24, representing a 54% decrease over approximately 2 years. The reason for the decline in distribution is an expected consequence of the fall in value of the underlying SLV shares. As each SLV becomes less valuable, the amount of call premium received for writing 3% out-of-the-money calls decreases proportionately (ceteris paribus).

In summary, SLVO has succeeded in providing high, albeit lumpy monthly income to unitholders. Unfortunately, the decline in SLV over the past three years has led to a proportionate reduction in call premium income paid out by SLVO.

Dividing the most recent 12 months of distributions ($1.24) by the current market price of SLVO ($9.24) gives a trailing twelve months [ttm] yield of 13.4%.

Discussion and conclusion

The discussion regarding SLVO is broadly similar to that of GLDI, as discussed in my previous article linked above. If taxes on distributions can be ignored (e.g. in a non-taxable account), then SLVO has indeed provided downside protection compared to an equivalent long position in SLV. Moreover, SLVO has succeeded in providing high, albeit lumpy income to its unitholders.

However, what all investors have to realize is that if SLV erodes in value, the distributions paid out by SLVI will also decline. Moreover, the cost of providing downside protection is that SLVO will lag SLV during rapid silver advances. Another source of SLVO underperformance is its relatively high expense ratio of 0.65%, although this will probably still be cheaper than trying to manage a portfolio of SLV shares and call options on your own. Moreover, the expense ratio is only 15 basis points higher than that of SLV's, at 0.50%. A final risk that applies to all ETNs is that their value is ultimately only secured by the credit-worthiness of the issuer, in this case Credit Suisse. Investors who view silver as an insurance policy in case of financial armageddon may prefer SLV, which is, in principle, backed by physical holdings,* or even actual physical silver itself, which can be hidden to everyone but yourself.

(*In my previous GLDI article, a reader pointed out his reservations about whether or not GLD/SLV possessed physical metal).

How would SLVO fit in as part of a diversified portfolio? According to InvestSpy, SLVI's daily variability (3.2%) and annualized volatility (21.7%) since inception are lower than those of SLV (3.8% and 25.9%, respectively), which is consistent with the notion that a call option strategy generally decreases volatility and smooths out returns compared to a long-only position. Additionally, both SLVO and SLV's relatively low beta values of 0.14 and 0.15, respectively, indicate that the price movements of these two silver funds have only little correlation with the movements of the broader stock market over the past three years. This is in contrast with silver miner stocks [via the Global X Silver Miners ETF (NYSEARCA:SIL)], which has a positive beta value of 0.69, indicating that silver miners tend to rise and fall with the stock market. In terms of total return, SIL has performed even worse than SLVO and SLV, with a -58.80% return over this time frame.

Ticker Annualized Volatility Beta Daily VaR (99%) Max Drawdown Total Return
SLVO 21.70% 0.14 3.20% -39.00% -35.00%
SLV 25.90% 0.15 3.80% -44.60% -41.00%
SIL 43.50% 0.69 6.40% -66.40% -58.80%
Click to enlarge

Lacking a crystal ball, I cannot tell you whether SLVO (or SLV) will rise in value in the future. But what the historical results over the past three years do tell us that SLVO has been a slightly safer way to obtain exposure to silver than SLV.

Finally, the correlation between the above three securities as well as with gold [via GLD], the broader market [via the SPDR S&P 500 Trust ETF (NYSEARCA:SPY)], long-term treasuries [via the iShares 20+ Year Treasury Bond ETF (NYSEARCA:TLT)], corporate bonds [via the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEARCA:LQD)] and high-yield bonds [via the SPDR Barclays Capital High Yield Bond ETF (NYSEARCA:JNK)] over the past three years is presented (source: InvestSpy). As expected, SLVO has little correlation (+0.08) with SPY, and only slight correlation with the three bond funds (+0.11-0.19). This suggests that the addition of SLVO to an equity-heavy portfolio should act to reduce the intra-portfolio correlation of the portfolio. Click to enlarge

A final warning from Credit Suisse should be included here:

[SLVO] should be purchased only by knowledgeable investors who understand the potential consequences of investing in a covered call strategy on SLV shares.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.