HIPS: It's Hard To Make A Good Recipe With Bad Ingredients

Summary

  • HIPS is a high-yield ETF with a portfolio diversified in CEFs, MLPs, mortgage REITs, and BDCs.
  • The yield is very attractive, but price history shows a steep capital decay.
  • The problem is structural: the 4 asset categories of its portfolio have the same issue.
  • An alternative high-yield strategy focused on total return.
  • Looking for a helping hand in the market? Members of Quantitative Risk & Value get exclusive ideas and guidance to navigate any climate. Learn More »

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This ETF review series aims at evaluating products regarding the relative past performance of their strategies and quality of their current portfolios. As holdings and their weights change over time, updated reviews are posted when necessary.

HIPS facts and portfolio

The GraniteShares HIPS US High Income ETF (NYSEARCA:HIPS) has been tracking the TFMS HIPS Index since 1/6/2015. It has 60 holdings, a monthly distribution with a 12-month yield of 9.88% and management fees of 0.70%. However, it is a fund of funds and the total expense ratio is 2.88%. This is a first red flag.

As described by GraniteShares in the prospectus, the rules-based Index measures the performance of up to 60 high income U.S.-listed securities that typically have “pass-through” structures that require them to distribute substantially all of their earnings to shareholders as cash distributions. This “high income, pass-through” strategy is known as HIPS.

Eligible securities must meet market capitalization and liquidity thresholds. Then, the Index selects up to 15 securities for each of four “pass-through” categories (REITs, MLPs, closed-end funds, asset management/BDCs) based on a score featuring yield (higher is better) and volatility (lower is better). Constituents are equal-weighted within each category. The weights of categories are adjusted to minimize volatility and maximize return, measured over a look-back period. A minimum category weight is set at 15% and a maximum MLPs weight at 25%. The Index is reconstituted annually and may be rebalanced quarterly under certain conditions.

HIPS currently has 51.7% of asset value in closed-end-funds, 19.2% in MLPs, 15.3% in BDCs, and 13.7% in REITs (mostly mortgage REITs). The fund is quite concentrated: the top 15 holdings, listed below, represent 51.6% of asset value.

Ticker

Name

Weight

FCT

First Trust Senior Floating Ra

3.91%

FINS

Angel Oak Financial Strategies

3.76%

JQC

Nuveen Credit Strategies Incom

3.76%

ARDC

Ares Dynamic Credit Allocation

3.53%

DLY

DoubleLine Yield Opportunities

3.53%

HYI

Western Asset High Yield Defin

3.52%

BGH

Barings Global Short Duration

3.45%

ISD

PGIM High Yield Bond Fund Inc.

3.43%

JRI

Nuveen Real Asset Income and G

3.42%

GHY

PGIM Global High Yield Fund Inc.

3.33%

EAD

Allspring Income Opportunities

3.33%

KIO

KKR Income Opportunities Fund

3.31%

HYT

BlackRock Corporate High Yield

3.27%

HIX

Western Asset High Income Fund

3.07%

EMD

Western Asset Emerging Markets Debt Fund Inc.

2.97%

Historical performance

The next table compares HIPS performance since inception with the S&P 500 and a more relevant benchmark: an equal-weight portfolio of 4 ETFs representing the 4 asset categories of HIPS, rebalanced annually. For this calculation, I have chosen Amplify High Income ETF (YYY), iShares Mortgage Real Estate ETF (REM), VanEck Vectors BDC Income ETF (BIZD), and ALPS Alerian MLP ETF (AMLP). Distributions are included and reinvested. Doing this, I have reduced the REIT universe to mortgage REITs. It may not be absolutely correct, but as yield is a primary factor of selection, selected REITs are mostly of the mortgage kind.

since 1/13/2015

Total Return

Annual.Return

Drawdown

Sharpe ratio

Volatility

HIPS

7.48%

0.94%

-54.04%

0.11

22.45%

YYY+REM+BIZD+AMLP

19.17%

2.30%

-56.31%

0.19

23.80%

SPY

106.96%

9.88%

-32.05%

0.63

15.62%

HIPS has been lagging the stock benchmark by far, and it is also behind the ETF mix by 1.36 percentage points in annualized return. It means the strategy has failed to bring added value over the mix of passive indexes. This is a second red flag.

The next chart compares HIPS with the 4 ETFs individually:

HIPS vs. YYY, REM, BIZD, AMLP

HIPS vs. YYY, REM, BIZD, AMLP (Portfolio123)

In fact, HIPS shows a capital decay of 40% since inception as of writing:

HIPS share price

HIPS share price (Google Finance)

Anyway, the 4 ETFs corresponding to the 4 “pass-through” categories have lost value in share price since their respective inceptions (see next charts).

YYY share price

YYY share price (Google Finance)

REM share price

REM share price (Google Finance)

BIZD share price

BIZD share price (Google Finance)

AMLP share price

AMLP share price (Google Finance)

The problem is structural, not related to management: it is almost impossible to make a good recipe with bad ingredients. Other similar ETFs like the Global X Alternative Income ETF (ALTY), reviewed here, have the same issues.

This issue is not specific to HIPS and ALTY: securities with yields above 6% suffer from capital decay. The 10-year average annualized return including dividends of all ETFs with a daily volume above $100k and a yield superior to 6% is 2.3%, for an average yield of 8.8% (data calculated with Portfolio123).

Capital decay also means income stream decay. HIPS has maintained a constant monthly distribution for a while, but I doubt it is sustainable. The yield cannot go up indefinitely to offset the loss in asset value.

The full picture for an income-seeking investor is not pretty, considering the current inflation rate and the tax paid on distributions. HIPS might be used as an instrument for swing trading or tactical allocation, but I don’t see it as a reasonable buy-and-hold investment. This is true for a number of high-yield instruments, not only this one.

A solution to get high yields without decay

Capital and income decay is a structural issue in many closed-end funds, like in most high-yield instruments. However, it is not inexorable if one knows how to trade CEFs instead of using them as buy-and-hold instruments. I designed a 5-factor ranking system statistically related to forward returns across the full CEF universe, and started publishing the 8 best-ranked liquid CEFs in Quantitative Risk & Value (QRV) after the March 2020 market meltdown. The list is updated every week. Its average dividend yield varies around 7-8%. It is not a model portfolio: trading the list every week is too costly in spreads and slippage. Its purpose is helping income investors find funds with a good entry point. In the table and chart below, I give the hypothetical example of starting a portfolio on 3/25/2020 with my initial “Best 8 Ranked CEFs” list and updating it every 3 months since then, ignoring intermediate updates to limit transaction costs. Return is calculated with holdings initially in equal weights using closing prices on quarterly rebalancing days, without trading cost. Dividends are reinvested at the beginning of every 3-month period.

since 3/25/2020

Total Return

Annual.Return

Drawdown

Sharpe ratio

Volatility

Best 8 CEFs quarterly

128.04%

38.57%

-20.21%

1.56

20.30%

SPY

54.21%

18.70%

-24.37%

0.82

19.51%

Best CEFs list performance

Best CEFs list performance (chart: author)

Dates and lists can be checked in QRV post history (trial is free). Past performance is not a guarantee of future return. Data calculated with Portfolio123.

The “Best 8” list has been quite volatile in 2022, but much more resilient than the broad equity and bond indexes. I don’t claim it will beat SPY in the future like it did in the past 2 years, but a discount-driven rotational strategy in CEFs has a much better chance to protect both capital and income stream against erosion and inflation than any high-yield passive investment like HIPS.

In these uncertain times, Quantitative Risk & Value (QRV) provides you with risk indicators and data-driven, time-tested strategies. Get started with a two-week free trial now.

This article was written by

Fred Piard profile picture
14.53K Followers
Data-driven portfolios and risk indicators.
Author of Quantitative Risk & Value and three books, I have been investing in systematic strategies since 2010. I have a PhD in computer science, an MSc in software engineering, an MSc in civil engineering and 30 years of professional experience in various sectors. My aim is making simple and efficient quantitative investing techniques available to my followers. Quantitative models can make investment decisions faster, reproducible and emotionless by focusing on relevant information in the middle of market noise. Moreover, models can be refined to meet specific risk tolerance and objectives. 

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I am an individual investor and an IT professional, not a finance professional. My writings are data analysis and opinions, not investment advice. They may contain inaccurate information, despite all the effort I put in them. Readers are responsible for all consequences of using information included in my work, and are encouraged to do their own research from various sources.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

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