DIVO - DIVO: Dividend Funds Are So 2022

2023-03-28 12:12:10 ET

Summary

• Amplify CWP Enhanced Dividend Income ETF is an outstanding income fund.
• But value and income are exactly the wrong places to be in 2023.
• Massive underperformance of DIVO is likely to continue, and it is not the place for your money.

I believe 2023 offers an opportunity for strong stock market gains. We’ve had a rough 14 months or so in the equity markets, pricing in all sorts of headwinds that have since come to fruition. However, it is my belief that the U.S. markets have already bottomed , and that we’re going to see higher prices this year.

Based on that belief, I have been telling subscribers that we want to be exposed to more risk to take advantage of higher prices ahead. Generally, during bull markets we tend to see growth-oriented assets outperform, and value- and income-oriented assets underperform. This is, of course, the opposite of what happens during weaker market periods, where value and income reign supreme while growth gets hammered. We’ve had over a year of that behavior, but it is my belief we’ve already seen the landscape change.

If I’m right about that, one place I do not believe you want your money is in dividend-oriented areas of the market. These are likely to underperform, and quite badly. In fact, that’s already happened so far this year, and I see more of this ahead.

In this article, we’ll take a look at a popular covered call fund, Amplify CWP Enhanced Dividend Income ETF ( DIVO ). The headline is that while this fund is good for what it is, this is exactly the wrong place to be in 2023.

What is DIVO?

DIVO is a covered call exchange-traded fund, or ETF, that focuses on large cap, “high quality” dividend stocks where the fund sells covered calls against long positions in the stocks it owns. This is a popular income strategy, and one that I’ve used many times in my life. It has several benefits, including the fact that when it’s executed on dividend stocks, the owner gets dividend income and covered call income, which juices the total income of the portfolio.

Selling covered calls can also reduce overall price volatility, as in exchange for the upside participation, one lowers their cost basis and has a downside hedge.

DIVO is actively managed, and turnover is quite high given it’s a covered call fund, and selling shorter-dated calls is better from a theta perspective, which is the decay one receives for selling an option. That has tax and fee implications, which I would encourage you to review here if you own DIVO, or are interested.

Here’s a visual representation of what DIVO is looking to do.

It’s concentrated with 33 stocks currently, so it does not offer the inherent diversification of an index fund. But in exchange for that concentration, one gets what should be the best of the best in terms of large cap dividend growth stocks, against which calls are written.

We can see that diversification among sectors is pretty good, but about half the fund is in financials, health care, and energy, which are traditionally income-oriented sectors of the market.

Its largest two holdings are tech stocks (we could debate Visa being a financial), but the next eight all come from those three sectors listed above. Diversification is overall pretty good considering the fund is actively managed and explicitly states it is not an index fund. Still, if you’re going to buy an income-oriented fund, you are likely already carrying the knowledge that you’re going to need exposure to energy/health care/financials.

Finally, DIVO is fairly large at $2.74 billion, and carries an expense ratio of 55bps.

The current yield is about 5.3%, which blows past the S&P 500’s (SP500) average of 1.6%. DIVO generates a combination of dividend and option income, which again, has tax implications. After all, juicing income returns isn’t free.

All in all, this is a strong fund, in my opinion. Seeking Alpha’s Quant system rates DIVO the very best nontraditional equity derivative income fund out of 14 choices, which is a fantastic stamp of approval.

The problem is that when I look at prospective returns for 2023, I want to be exposed to growth, not value and income. Permit me to explain.

Dividend funds are so 2022

As I mentioned above, there is a time and a place for income-oriented stocks. During weak periods in the market, value and income dominate. That’s because Wall Street positions for lower prices ahead, and you’ll hear the term “flight to safety,” which simply means money is flowing out of riskier areas and into less risky areas of the market. In practice, that's out of growth, tech, consumer discretionary, and into consumer staples, utilities, and the like.

That worked really well from the top the market put in a little over a year ago, but that time has passed. Let’s now take a look at a chart of DIVO, and some relative price action that supports why I think you should divest your dividend-heavy holdings and buy some risk exposure.

DIVO is in a downtrend, and has been since December. That makes perfect sense to me because risk-oriented sectors of the market have been soaring, and destroying value and income on a relative basis. As I mentioned, it is my view this will be the theme for 2023.

DIVO’s chart is pretty ugly, as momentum has fallen off a cliff, support levels aren’t being respected, and the underperformance is just awful. DIVO has lost about 6% relative to the S&P 500 YTD, while it has ceded more than 16% to the Nasdaq YTD. Even if you like having a 5.3% yield, losing 16% on a relative basis in the space of three months has to hurt.

In other words, you could have just owned a Nasdaq index fund for three months, sold it, and generated more profit on a relative basis than three years’ worth of holding DIVO for income. This is why it’s so important to get sector allocation right, and DIVO is simply the wrong place to be, even if it is the best in its class.

Wrapping up

As I mentioned before, Amplify CWP Enhanced Dividend Income ETF is a really strong income fund, and there will be a place for it at some point in the future. However, owning DIVO is like owning a really fancy mansion in a crime-ridden, dilapidated neighborhood. It is my belief this year will continue to offer growth outperformance of value and income, and DIVO is heavy into the latter two of those characteristics. Will DIVO end the year higher than it is now? Maybe. Will it beat the Nasdaq, or S&P 500? I am betting it won’t, and I’m also betting it won’t even come close. Just to reiterate, it's already lost 16% relative to the Nasdaq and we're only one quarter of the way through the year.

Covered call funds are great during sideways and down periods in the market, and Amplify CWP Enhanced Dividend Income ETF is among the best. But this is not the time for that kind of fund, so despite DIVO’s excellence, it’s simply the wrong place to be.

For further details see: