DVY - ALTY: High Yield ETF With Shrinking Value And Distributions

Summary

• ALTY is an ETF diversified in five high-yield asset categories.
• Share price and income stream have shrunk by more than 20% since 2016.
• The new underlying index is a marginal improvement, but it doesn’t look attractive.
• How to manage capital decay in high yield securities.

ALTY facts and portfolio

The Global X Alternative Income ETF ( ALTY ), previously known as Global X SuperDividend Alternatives ETF, is a high yield fund paying monthly distributions with a 12-month distribution yield of 8.29%. It was launched on 07/13/2015 and tracks the Indxx SuperDividend Alternatives Index, a rule-based strategy mixing different categories of securities. The name, index and strategy have changed on 9/28/2021. It's mostly a fund of funds.

According to Global X ETF's website , the index offers an exposure to five asset categories: Infrastructure/MLPs, real estate, preferreds, emerging market bonds and covered calls. For the real estate, preferreds, emerging market bonds and covered calls parts, it just holds other ETF by the same firm: Global X SuperDividend REIT ETF ( SRET ), Global X U.S. Preferred ETF ( PFFD ), Global X Emerging Markets Bond ETF ( EMBD ), and Global X Nasdaq 100 Covered Call ETF ( QYLD ). For the infrastructure/MLPs part, it invests directly in MLPs and shares of infrastructure companies. The five categories are equally weighted at 20% at each annual reconstitution. They may be rebalanced quarterly if any one of them deviates more than 3% from its target weigh. It has a total of 19 holdings.

In the previous version of underlying index (until September 2021), it was holding the same real estate ETF, about 13 closed-end funds and 30 stocks of infrastructure and asset management companies. The new structure eliminating CEFs resulted in cutting the total expense ratio from 2.8% to 0.5%.

Components

Let’s have a look at share price charts of ALTY’s main constituents:

The next one is not a real portfolio holding. I take it as a proxy for the infrastructure/MLPs part.

The next table reports the performance of a simulated portfolio holding these five ETFs since 1/1/2020, rebalanced quarterly as ALTY does, compared with a dividend benchmark: the iShares Select Dividend ETF ( DVY ). This time, dividends are included.

All ETFs held by ALTY have suffered a capital decay since their respective inceptions. The infrastructure/MLPs part, simulated by MLPX, is close to flat. The new ALTY is likely to suffer from capital decay, but probably less steep than the old version.

Since inception (with two versions of underlying index), ALTY has lost about 23% in share price.

Capital decay also means income stream decay: The yield cannot go up continuously to offset the loss in asset value. The annual sum of distributions was $1.22 per share in 2016 and $0.92 in 2021 ( source ). This represents a 24% reduction in income stream. The full picture for an income-seeking investor is not pretty, considering the current inflation rate and the tax paid on distributions.

This issue is not specific to ALTY: Securities with yields above 6% suffer from capital decay. The 10-year average annualized return including dividends of all ETFs with a yield superior to 6% is 4.5%… for an average yield over 8%!

ALTY managers have improved their product with the new version by drastically reducing the total expense ratio. However, it’s nearly impossible to make a good recipe with bad ingredients. ALTY might be used as an instrument for swing trading or tactical allocation, but I definitely wouldn't include it my retirement plan. 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's 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 eight 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's 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 three 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 three-month period.

The usual disclaimer says that past performance (real or simulated) is not representative of future return. To be honest, the “Best 8” list is unlikely to perform as well in a near future as since March 2020. The 2020 meltdown and recovery resulted in price dislocation and exceptional opportunities in the CEF universe. The 2022 downturn also was a source of opportunities in energy and infrastructure funds. This is unlikely to be reproducible in the future. However, I think 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 ALTY. Dates and lists can be checked in QRV post history.

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