KNG: Hybrid Income ETF Review

Summary

• KNG strategy and performance.
• Comparing KNG with a reference strategy.
• Scanning KNG with quality metrics.
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This dividend ETF review series aims at evaluating products regarding the relative past performance of their strategies and quality metrics of their current portfolios.

KNG strategy and performance

The CBOE Vest S&P 500 Dividend Aristocrats Target Income ETF (BATS:KNG) has been tracking the CBOE S&P 500 Dividend Aristocrats Target Income Index Monthly Series (ticker: SPATI) since March 2018. Its SEC yield is 3.14% and the total expense ratio is 0.75%. KNG provides income by holding dividend stocks and selling covered call options on these stocks.

As described in the prospectus available on CBOE Vest website:

The Index is composed of two parts: (1) an equal-weighted portfolio of the stocks contained in the S&P 500 Dividend Aristocrats Index (the “Aristocrat Stocks”) that have options that trade on a national securities exchange and (2) a rolling series of short (written) call options on each of the Aristocrat Stocks (the “Covered Calls”). The S&P 500 Dividend Aristocrats Index generally includes companies in the S&P 500 Index that have increased dividend payments each year for at least 25 consecutive years and meet certain market capitalization and liquidity requirements.

Some important points of the strategy:

• Equity components are reconstituted annually and rebalanced quarterly.
• Covered Calls are written on no more than 20% of the position in each stock.
• Covered Calls are written each month to expire the following month at a strike price close to the last daily closing price.

Since inception (3/27/2018), KNG has lagged the S&P 500 (SPY) by almost four percentage points in annualized return. It shows similar risk metrics (drawdown and volatility).

	Annual Return	Drawdown	Sharpe ratio	Volatility
KNG	14.34%	-32.57%	0.78	17.63%
SPY	18.12%	-32.05%	0.95	17.96%

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The next chart plots the equity value of $100 invested in KNG and SPY since inception, reinvesting dividends.

KNG performance looks disappointing, but three years of historical data are not enough to assess its merits.

Comparing KNG with a reference strategy

In previous articles, I have shown how three factors may help cut the risk in a dividend portfolio: Return on Assets, Piotroski F-score, and Altman Z-score.

The next table compares KNG since inception with a subset of the S&P 500: stocks paying a dividend with an above-average ROA, a good Altman Z-score, a good Piotroski F-score and a sustainable payout ratio. The subset is rebalanced quarterly.

	Annual Return	Drawdown	Sharpe ratio	Volatility
KNG	14.34%	-32.57%	0.78	17.63%
Dividend & quality subset	15.00%	-32.91%	0.77	19.06%

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Past performance is not a guarantee of future returns. Data Source: Portfolio123

KNG metrics are close to my dividend quality benchmark. It is not exceptional, but rather a good point. ETF return is real and this subset is hypothetical.

Scanning KNG with quality metrics

KNG holds 64 stocks and the same number of positions in options on these stocks. Eight of them are risky regarding my metrics. These are companies with at least two red flags: bad Piotroski score, negative ROA, unsustainable payout ratio, bad or dubious Altman Z-score, excluding financials and real estate for which these metrics are less reliable. Risky stocks weigh 12% of the portfolio, which is acceptable. The position-weighted average ROA is a bit better than for the S&P 500: 7.1% vs 5.8%. The Altman Z-score and Piotroski F-score are similar: 4 vs. 3.9 and 5.5 vs. 5.4, respectively. These metrics point to a portfolio quality slightly superior to the benchmark.

KNG vs. VIG

The Vanguard Dividend Appreciation ETF (VIG) is my preferred benchmark for dividend-oriented ETFs (and I hold it). VIG has a lower yield, a lower management fee (0.06% vs. 0.75%) and better return and risk metrics since KNG inception.

	Annual Return	Drawdown	Sharpe ratio	Volatility
KNG	14.34%	-32.57%	0.78	17.63%
VIG	16.91%	-29.58%	0.99	15.81%

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Conclusion

KNG holds 64 dividend aristocrats and sells short-term covered calls on them every month. No more than 20% of each stock position is hedged by options. Portfolio quality is slightly above the benchmark according to my metrics. However, hedging and quality don’t materialize in a measurable risk reduction on price volatility and drawdown. The 3%-plus yield is attractive for income-oriented investors, but management fees are high and total return since inception is disappointing compared to VIG (review here) and RDVY (review), some of its competitors in the dividend ETF arena. KNG results are not compelling, but it may be too early to judge it with only three years of data.

For transparency, my equity investments are split between a passive ETF allocation and an actively managed stock portfolio, whose positions and trades are disclosed in Quantitative Risk & Value.

Analyst’s Disclosure: I am/we are long VIG. 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.