My writing career on Seeking Alpha has predominantly focused on covering Income Ideas in exchange-traded funds and closed-end funds.
It was only a matter of time until I covered the ETF which is investing in CEFs, right?
Throughout my career as an investment advisor, I found there were generally two types of closed-end fund investors. The first group is the income-focused, but less knowledgeable investors. They either found closed-end funds through doing a search for high dividend-paying "stocks" or, as in many cases, were elderly investors who were sold the closed-end fund by their wirehouse/Wall St. broker. They like the income but generally do not understand where it comes from.
The second group of investors are those that you may find reading articles like this one here on Seeking Alpha or discussing closed-end funds on other investor message boards. These investors generally understand what makes a closed-end fund work and are knowledgeable about basic principles such as: 1. a distribution is NOT a dividend, 2. the market price is NOT what the fund is worth, and 3. you have to read the financial statements to figure out whether a fund is safe or not.
To be a successful closed-end fund investor over the long term, you have to take the time and spend it on research and due diligence.
For those investors who do not have it but perhaps want a better chance, sponsors like YieldShares come out with products such as the YieldShares High Income ETF (YYY).
The YieldShares High Income ETF follows an index that seeks to provide a high current income by investing in 30 closed-end funds ranked by their distribution yield, discount to net asset value, and liquidity.
Is it a good idea? Has the fund delivered? Let's take a look.
While the fund website does not do as good of a job making an investment case as we have come to expect from larger ETF providers such as iShares, VanEck, and others, the YieldShares fact sheet does.
As we discussed above, the fund is meant to be an all in one solution for deriving income from the 30 "best" closed-end funds.
This is purely targeted at investors who may want to invest in closed-end funds but do not have the time, skills, or desire to investigate the funds themselves.
Source: YieldShares FactSheet
As per the sponsor, the three main reasons to pick the fund are the basic reasons to look into closed-end funds, 1. a high distribution income, 2. ability to purchase funds at a substantial discount to their value, and 3. diversification.
Source: YieldShares FactSheet
- Sponsor: YieldShares by Amplify ETFs
- Index: ISE High Income Index™
- AUM: Approximately $211 million (3/13/2019)
- Historical Style: Diversified Closed End Funds
- Investment Objectives: The YieldShares High Income ETF seeks to provide investment results that, before fees and expenses, correspond generally to the price and yield performance of the ISE High Income™ Index.
- Number of Holdings: 30 securities.
- Current Yield: 8.08%. 30-Day SEC Yield
- Inception Date: 6/21/2013.
- Fees: .50% (+1.52% Acquired Fund Fees).
Source: YCharts & YieldShares
The Index & The Fund
One of the challenges that I have is finding the balance between what I should expect from a sponsor versus what they can provide.
When looking at ETFs and funds from larger sponsors like iShares and Nuveen, you almost always have all of the information that you want on a website, easily found and presented in a format that you can work with.
With smaller sponsors, I have an issue. On one hand, I want smaller sponsors to succeed, on the other hand, they generally do a poor job letting you find the information that you want and need for due diligence and force you to hunt for it yourself. It is almost like companies that link to their shortened earnings reports with selected information rather than the actual 10K and 10Qs filed with the SEC which disclose all of the required facts.
Amplify ETFs does a decent job but can surely use some work on their website. While easy-to-find links to the prospectus and reports are appreciated, it would also help to have a link to the underlying index methodology, or a better break down of holdings by sponsor, by sector, etc.
As we can see, even though the ETF was launched in 2013, the underlying index has been around since 12/31/2003 and is currently made up of 30 holdings.
Nasdaq and ISE do a GREAT job discussing the index methodology, especially for one that has a number of moving components.
So, let's dive into the index methodology.
The index starts with the investable universe of strictly closed-end funds.
In order to be eligible for inclusion, the CEF has to be traded on either the Nasdaq, NYSE, NYSE American, or the CBOE exchanges.
Furthermore, the CEF must have a minimum market capitalization of $500 million and must have a daily six-month average traded value of at least $1 million.
Source: Nasdaq Methodology
Doing such a screen today would provide a list of about 140 closed-end funds.
The funds are then ranked by their distribution yield, discount to NAV, and their average daily value of shares traded.
The individual ranks are then combined with a 50%, 25%, 25% weighting methodology.
Then, the funds are re-ranked, and the top 30 names are selected for the portfolio.
Source: Nasdaq Methodology
The components are then adjusted to weight no more than 4.25%.
The index is then evaluated annually in December and rebalanced in the beginning of January.
If at any time, during the year, a component becomes ineligible, it is removed and not replaced.
Turning to the fund, we can indeed find that it is fairly concentrated.
Looking at the top 10 holdings shows us a portfolio made up of a number of funds I have previously discussed in the past. DSL, JPS, FPF, RA, HIX, AOD, EMD, AWF, HYT, and BIT make up 42.66% of the overall ETF.
Due to the focus on income, the fund is largely focused on fixed income CEFs.
While a bit outdated, the fund was fairly well diversified amongst sponsors with the top 5 being Legg Mason, BlackRock, Prudential, First Trust, and Nuveen.
Source: YieldShares YYY FactSheet
Generally speaking, the fixed income exposure has been on the corporate side with very little to no municipal bond exposure.
The debt that they do have is largely junk bonds, as expected with the methodology.
Despite the price per share lacking since inception, the fund has been fairly successful in raising capital. The current $211 million is surely enough to pay for the fund's organizational expenses but by no means is it really successful versus a typical ETF from a larger sponsor.
The fund has managed to stay on the right side of the flows since its launch.
Year to date, the fund has done quite well and has achieved a 12.33% total return. The price per share increased 10.66%. This was in line with other closed-end funds and a broader market rally post 2018.
It has been volatile, of course, and if we look back to the previous 12 months, we find the investment would earn you a 3.54% total return, while the underlying price per share declined 5.18%.
Looking back three years, we see the importance of income as a component of total return, more specifically in this case... ALL of the return.
YYY achieved a 30.75% total return, all of it coming from distributions. The price per share declined 0.06% over the last three years.
Looking back over the last 5 years, however, does present a bit more of a concerning picture with a total return of just 19.47%. The price per share declined 24.4%. This implies that the bulk of the distributors where either your own money coming back to you, or some of those closed-end funds were really bad performers.
Looking back through to since inception, the fund has achieved a total return of 50.21%, while the underlying price per share declined 11.91%.
Chasing income through CEFs is a fairly successful idea and why the YieldShares fund is not alone. Competing directly with this ETF are the Invesco CEF Income Composite ETF (PCEF), the First Trust CEF Income Opportunity ETF (FCEF), the Saba Closed End Funds ETF (CEFS), and even a municipal CEF focused VanEck Vectors CEF Municipal Income ETF (XMPT).
Just to see how it performed against a good quality focused municipal CEF, we can look against the Nuveen AMT Free Quality Muni Fund (NEA).
Year to date, we have an interesting but not a surprising result, at least to me. The two competing ETFs, the Saba and First Trust CEFs, outperformed the YieldShares ETF. One of the reasons perhaps is that they are both actively managed, or less restrictive.
Going back over the last year, we still find the Saba fund outperforming YYY, but slightly. All of the ETFs, however, were outperformed by the VanEck municipal bond-focused ETF and the Nuveen Muni CEF.
Going back to the earliest common date in early 2017, we find a repeat of the YTD numbers. The more actively managed ETFs have outperformed the YieldShares fund.
To get a longer term track record, we had to take out the Saba and First Trust funds.
Over the 5-year picture, we do find the YieldShares fund lagging the Invesco ETF. Both of which lagged the VanEck municipal focused ETF and Nuveen CEFs.
Going back through to since inception, we once again find the YieldShares ETF was outperformed. It did meaningfully outperform in 2014; however, has lagged since then.
2013 was a bad year for municipal bonds, and as a result, they lagged.
Overall, the results are not surprising.
I am really glad I looked at this ETF, simply to get a better understanding of it, how it works, and what the appeal of it is to retail investors. It also helped diving into the methodology to see where the ETF can inadvertently hurt investors. As we discussed many times, there is often a disconnect between what the ETF advertises and what it actually does.
In the case of the YieldShares ETF, I think it does exactly what it is supposed to do. Would I invest it in myself? No.
Would I recommend others to invest in the fund? Eh... much tougher.
It is certainly better than blindly picking funds or other high income-focused ETFs like the Global X SuperDividend ETF (SDIV), which I wrote about previously.
The YieldShares High Income ETF does have a few "flaws" so to speak and why I believe it was fairly consistently outperformed by its peers.
As we know, the fund focuses on CEFs that are $500 million in market cap or greater. This effectively cuts the investable universe from over 400 funds to under 150.
Some of the BEST opportunities which we have seen over the past few years are in funds that are around $100 million to $400 million in size.
Secondly, it does focus 50% on both the trading value/volume and the discount to NAV.
While doing so is good for liquidity, I don't believe those two factors looked at in a vacuum are critical.
Furthermore, once we add in the distribution rankings, the fund does have a bit of the yield chase characteristics seen in other funds that are popular in a bull market but which end up performing horribly in flat to down markets. The reason why YYY has not blown up is that it focuses on the largest closed-end funds.
Which leads to the biggest issue... the fund focuses on the distribution. It does not AT ALL factor in distribution coverage, or the health of the distribution.
Eventually, the distribution cut happens and the portfolio THEN gets rebalanced at the end of the year... by that time, it may be too late.
YET... simply looking at the fund's distribution coverage as published in either sponsor reports or on other sites, investors are able to see a distribution cut from a mile away. They can be proactive, rather than reactive.
This fund is reactive. Its competitors, the more actively managed ETFs from First Trust and SABA, are proactive, and why it is no surprise to see them outperform.
I believe this ETF would be made far better if the index methodology also took into account distribution coverage over prior 12 months, either as an exclusion factor, or as a weighting in the rankings.
Beyond that, we do see that for this fund, essentially all of the total return came from distributions (and most certainly, a substantial amount of it being return of capital).
Depending on where you are investing the money, if the funds are in a taxable, non-qualified account, I would simply pick up a well-managed, quality municipal bond fund. The After Tax Equivalent returns are going to be in the same ballpark, and over a number of periods better, and generally have lower volatility.
Furthermore, if you believe that a recession is coming and the Fed will soon be forced to lower interest rates again, municipal bonds may also present some capital gains opportunities. You can either pick your own municipal CEFs or use an ETF such as the VanEck Muni CEF ETF.
Finally, another reminder to investors, this is a fund of funds. As such, the .5% management fee is not the only fee. Levered closed-end funds are expensive, and you are paying those fund fees in addition to the YieldShares fee. As of the latest quote, the acquired fund fees were 1.52%. With the rate hikes, this has most certainly gone up.
So, there you go. Thanks for reading! I hope that was helpful and look forward to your questions or comments.
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.