Although markets have been shaky as of late, ETF providers are diving head first into new products. A host of fresh funds have hit the market recently, targeting a variety of new market segments in the process.
There has even been a new ETF provider launching its first fund, YieldShares, in this time frame. This company, led by former Claymore Securities veteran Christian Magoon, is now stepping into the spotlight in the extremely competitive yield space with their brand new High Income ETF (YYY).
Obviously, this is a tough time to launch a yield-focused ETF, as Fed policies have dulled the appeal of some income securities, as investors cycle away from this asset class for the time being. Yet with that being said, there are a few key aspects to YYY which could make the fund an interesting choice regardless of the broader market environment.
YYY in Focus
This new ETF looks to track the ISE High Income Index, a benchmark of 30 closed-end funds (CEFs) that seek to provide investors with high current monthly income levels. CEFs are included within the benchmark when they rank the highest overall on three key metrics; yield, discount to net asset value, and liquidity (read Two Unconventional Sources of ETF Yield).
Currently, this results in a benchmark that has an indicated yield of 10.3%, and an average CEF discount of 7.6%, according to the ISE index page. Equity CEFs make up just over half the portfolio, while debt accounts for a quarter of the assets, giving the overall duration level a reading of 1.4 years, putting it decidedly at the low end of the curve.
Top ranked CEFs receive the greatest weight, while the lowest ranked funds receive the smallest weighting. However, the biggest holding is capped at 4.25%, in order to prevent concentration issues and spread assets around the 30 index constituents.
Closed-End Funds 101
For investors unfamiliar with closed-end funds, it is probably helpful to note some of the basics about the space. First off, CEFs were the precursor to open-ended mutual funds, having made their debut in the mid 1890’s.
These products raise a fixed amount of capital, and then invest it in a variety of securities. Investors can then buy or sell these CEFs shares on the open market, though unlike ETFs or even many mutual funds, no new shares are created or redeemed (see ETFs vs. Mutual Funds).
Without this creation/redemption process, closed-end funds can deviate significantly from their net asset value (NAV). Add in the fact that these are usually less traded than their ETF counterparts, and a discount to NAV usually develops for CEFs.
This means that CEFs often trade at level that is below what their net asset value is worth, hence the terminology of ‘trading at a discount’. Still, many of these closed-end funds have income strategies and can make it easier for some to tap into little-appreciated or extremely illiquid techniques.
So by putting this approach in an ETF structure, investors can potentially obtain the best of both worlds; the liquidity of the ETF along with the income and diversification of a CEF.
The main competitor to YYY is the established PowerShares CEF Income Composite Portfolio (PCEF). This product also focuses in on closed-end funds, and it has already seen a great deal of interest from investors, as evidenced by its $450 million in assets under management (also see Closed End ETFs for Forgotten 7% Yield?).
The product is a bit pricier than YYY though, as it has an expense ratio of 1.73% (with a management fee of 50 basis points) compared to an expense ratio of 1.65% for the YieldShares product (also with a 0.50% management fee). It does also hold more CEFs than its new counterpart, holding over 140 in total.
This suggests that PCEF may be a broader play on the space, and thus a more well-rounded choice for the CEF market. However, the SEC 30 Day Yield is just below 8%, so there is a bit of a sacrifice on the income front for this broader exposure.
Income investing has been quite rough lately, as a possible shift in Fed policies has dulled the appeal of high yield stocks. Still, there are plenty of decent options out there to generate income with lower risks, especially when you look to lower duration securities (see What Does Your Income ETF Focus On?).
One little known way to do this is by targeting CEFs, which can not only provide investors with high rates of income, but can have ultra-low durations as well. When you add in a focus on CEFs trading at a discount to NAV, you may have a winning combination with this strategy, especially in today’s type of market.
So while competition may be fierce in the income ETF world, YYY is definitely worth a closer look. The product takes a novel approach to income investing, which just may be the technique investors need to use in this uncertain economic environment.
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