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A Balanced Approach for ETF Investors Seeking Income Generation

This article was originally published on ETFTrends.com.

As fixed-income investors look for ways to diversify a portfolio and better manage risk, one may consider an actively managed exchange traded fund strategy that seeks a complete approach to total returns, pursuing returns on capital on a foundation of return of capital.

In the recent webcast, Total Return Alternatives: Balancing Portfolio Risks When Even Junk Yields Less than 5%, John Lueken, Executive Vice President and Chief Investment Strategist, CapWealth Group, warned that no one can definitively say where the markets are heading since sentiment and conditions can turn on a dime. For example in the fixed-income markets, we were looking at a near 100% probability of rate hikes at the end of November 2018 then a 70% probability of a rate cut at the end of March 2019. Consequently, many money managers have taken a hit from bearish wagers on global interest rates this year.

In the current global fixed-income environment, we are looking at an increasingly lower-for-longer yield outlook. There is even $17 trillion in negative yielding bonds globally, or greater than 30% of global tradeable bonds. Lueken warned that the negative yields are now causing a distortion in the pricing of duration and credit risk as depressed rates in very negative territory for prolonged periods is unleashing more unintended consequences than benefits.

Adam Eagleston, Portfolio Manager, Driehaus Capital Management, noted that in the U.S. we are experiencing near historic low yields for bonds, and the demand for yielding assets has also depressed yields on stocks as well.

As a response to the depressed income opportunities, investors are scrambling for yields, which we have seen in investment flows across funds. For example, through the end of June, bond funds and ETFs have outsold stock funds and ETFs by over $245 billion, or the largest six month difference in flows since 1993. Through September 4, bond funds and ETFs have attracted $337 billion in new money as the disparity between equity outflows and bond inflows hits a record. This sudden influx into bonds has even caused some to call long U.S. Treasuries one of the most crowded trades.

Eagleston also pointed out that bonds have been a great source of returns as well. Bonds have generated greater price appreciation than stocks since 2000. During the recent bull market from 1981 through 2019, long-term government bonds have shown an average annualized return of 9.6%.

As a way to better manage risk and pursue returns, JD Gardner, Founder, and Chief Investment Officer, Aptus Capital Advisors, highlighted the actively managed Aptus Defined Risk ETF (Cboe: DRSK) that incorporates a combination of a laddered bond portfolio strategy with options on U.S. equities to help investors achieve income and growth through a hybrid fixed income and equity approach.

The Aptus Defined Risk ETF has held up in the recent bout of market volatility. In the period August 8 through August 30, DRSK increased 15.9%, whereas the S&P 500 added 5.4%. Over other periods, DRSK has exhibited much lower drawdowns compared to the S&P 500 as well, providing a source of uncorrelated returns to a diversified investment portfolio.

The active ETF tries to generate income and capital appreciation by investing in 90% to 95% of its assets in a 1-7 year laddered investment-grade corporate bonds and the remainder in large-cap U.S. stocks while limiting downside risk.

Gardner said advisors are looking to DRSK as a way to gain exposure to fixed income for higher returns without extending duration or taking on additional credit risk, to equity for clients who may be overly reliant on fixed income to embrace equity exposure in a risk-managed way, and to alternatives for a low-correlation stock/bond diversifier in a liquid, transparent ETF vehicle.

Financial advisors who are interested in learning more about defined risk strategies can watch the webcast here on demand.

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