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Looking for Defensive Ideas

Posted by Dan Weiskopf, ETF Professor on Apr 20, 2022 10:30:00 AM
Dan Weiskopf, ETF Professor
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In the ETF Think Tank, the Capital One slogan “What’s in your wallet” could mean a lot of things: Investing in Growth? Thematic? Value? And yes, it could even refer to Blockchain. However, today we will simply look to highlight a couple of alternative ideas that are potentially useful for investors who want to play defense. After all, investment conditions in 2022 are different than in recent memory, and this slogan was really designed to reference the “stuff in your wallet” - financial security, purchasing power and prosperity. To this point, whether an investor believes inflation is transitory or not may not be as important as the fact is that it is here today at 8.5%, a 40 year high (see below chart and link).


Aligning portfolios with this new trend has its pitfalls and challenges since energy prices have increased 32%, namely gasoline (48%) and fuel (70.1%). When reweighting, we encourage investors not to chase the hot-dot unless they understand the exposure they are taking on with this volatile commodity. Note that the Energy Select Sector SPDR Fund (XLE) is up 45.2% YTD and 12 months vs a decline of 7.42% for the SPY (4-14-22).

1-Year Performance Ending April 14

In a recent ETF Think Tank post, we highlighted BTAL as a hedging tool, Sick of Smart Market Beta: Check Out the Anti-Beta ETF. Note that the below graphs include the AGF BTAL to manage the deep drawdowns, and the Nuveen Short Term REIT ETF (NURE). As stated on the Nuveen website, the ETF provides exposure to U.S. Real Estate Investment Trusts (REITs) with short-term lease agreements which may exhibit less price sensitivity to interest rate changes than REITs with longer-term lease agreements. Note the input 1-Year return from XLE is impressive at 69.70% and technicians may point out that the long-term earlier years basing provides for a great deal of upside.


Year To Date Chart (YTD April 14, 2022)

In the above comments, we highlight what has happened over this past year in these few funds. Our choice of highlighting XLE is random, since anything oil or energy related has moved in a similar degree. XLE is, of course, top of mind since it was launched in 1998 (12-16-98) and has the most AUM of any energy related ETF ($38.67 billion) currently. However, it is also overweighted in Exxon (22.68%) and Chevron (21.69%), so this concentration is the primary factor of its current performance. To that point, while a bounce of nearly 70% over a year is impressive, a three-month acceleration of 45% is parabolic. Congratulations to those who caught the trade, but for investors, we think the inflation trade is bigger than just oil.


Two ETFs That Use Options

Where to hide? Volatility can create opportunity in option-writing and protective put-option hedging, which is highly tax-efficient when wrapped in an ETF. Two ETFs we have been constructive on are the Core Alternative ETF (CCOR) and the Amplify CWP Enhanced Dividend Income ETF (DIVO). Note that both have considerably higher weighting in energy than what is in the SPY. In the case of DIVO, the weighting is 10.84%. At 5.48%, CCOR is still about double that of the SPY (<3%). Covered call writing combined with high dividend can generate a nice cash flow yield. DIVO has paid a steady $.14 to $.15 a month, and CCOR just bumped its quarterly rate to $.13 a share. There was a lot of chatter at the ExchangeETF conference on how active is finally getting flows. Curiously, these two actively managed Funds currently have only 27% overlap and have different mandates, so there is room to own both. CCOR is designed as an all-weather defender in terms of how it manages downside protection using put options. (see presentation link) DIVO’s solution focuses on high quality dividend companies which may hedge against shallow drawdowns with the covered calls and earned dividends. (see link)



How is your wallet aligned with future inflation trends? Do you believe inflation will peak soon, is transitory in nature or could we see a 4-7% rate of inflation for a while? ETFs that provide access to energy, Real Estate, the spread between High vs Low Beta factor and the smart use of options could be considerations depending upon your view. However, most importantly, since it is unlikely that inflation will normalize back to sub 2%, cash and short-term fixed income may not be your best solution to generate positive absolute return after inflation. Moreover, those investments that have worked in the past in the pre-inflation era may not be so effective in the future since conditions have so dramatically changed. Our recommendation: review, assess and address! Structure Matters!!


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Topics: Weekly Research, Structure Matters

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