DIVO - DIVO Underperforms In 2023 But It's A Long Play For Conservative Investors

2023-08-20 05:21:11 ET

Summary

• Amplify CWP Enhanced Dividend Income ETF outperformed the S&P 500 in 2022 but has underperformed in 2023.
• DIVO is a Dow Jones oriented fund, so its performance closely matches the performance of the Dow Jones index.
• The fund's underperformance in 2023 wasn't because of covered calls but it was because of Dow's underperformance.
• In the long run, this is still suitable for investors who like stable and growing income with less risk.

Amplify CWP Enhanced Dividend Income ETF ( DIVO ) was one of the "star players" of 2022 when the fund outperformed S&P 500 ( SPY ) while we were in a bear market so people were very excited about this fund's prospects in 2023 as a new bull market was beginning. The idea was that if it's doing so well during a bear market, it must prosper even more during a bull market but it hasn't happened so far. In this article I will try to explain why and offer my comments on DIVO.

This is not my first article on DIVO. I had published another article on this a few months ago saying that I am buying the dip in DIVO. Since then the fund recovered a bit but it's still underperforming S&P 500 index which is considered the ultimate benchmark.

In order to explain why DIVO has been underperforming in 2023, let us start by looking at how three indices performed in 2023. Notice the big discrepancy between the three indices. Nasdaq is up 27% year to date (not to mention it was up 36% just a couple weeks ago), S&P 500 is up 14% (was up almost 20% not long ago) while Dow is up only 4%. It is very typical for Nasdaq to outperform S&P 500 and S&P 500 to outperform Dow in bull markets but not by this much. In a typical year Nasdaq is expected to rise about 10%, S&P 500 by 8-9% and Dow by 7-8% but not this year.

To be fair, we saw an opposite relationship last year where Nasdaq was down -33%, S&P was down -20% and Dow was down only -8% so it makes sense for Nasdaq to climb much higher than Dow to play catch up from last year.

So, you may be wondering why I am even showing this and what this has to do with DIVO's outperformances in 2022 and underperformance in 2023. Well, as it turns out, DIVO is more or less a Dow fund. Last year the fund was holding 34 and 29 of them were Dow Jones components. As of writing of this article, it's holding 23 stocks of which 20 are Dow stocks. So this fund is a Dow Jones oriented fund and its performance will closely match the performance of Dow Jones index. When Dow outperforms S&P 500, so will this fund (for the most part) and when S&P 500 outperforms, this fund will most likely underperform as well.

Also notice that 14% of the fund's assets are currently invested in a short term bond index which will generate about 5.5% virtually risk-free but this will also limit the upside in the fund because bonds are still in a bear market since last year and bond prices haven't been rising for a while.

There is a common misconception that DIVO's performance is held back because the fund is writing covered calls against its positions, thus limiting its upside significantly but this is not true. Yes, DIVO writes covered calls against its positions and actively manages those but it only writes calls against 20% of its holdings and the fund lets most of its positions run freely.

DIVO's goal is to generate a dividend distribution yield of 5%. Currently Dow Jones index has a dividend yield close to 2%, plus there is some yield coming from the fund's bond holdings, which means the fund only needs to generate another 3% from selling covered calls which is not that much.

When we look at the fund's current holdings, we only see a few calls written. While the fund is actively managed and these are subject to change without a notice on almost daily basis, the fund is currently shorting Apple ( AAPL ) $190 calls, McDonald's ( MCD ) $292.5 calls and two sets of UPS ( UPS ) $180 calls expiring in August and September. All these call options are currently out of money but they might not have been when they were written since markets have been in a pullback mode for the last 2 weeks.

The fund writes covered calls against individual stocks as opposed to Dow Index which is closely represents because IVs are much higher in individual stocks. The fund could have easily written DIA ( DIA ) covered calls corresponding to 20% of its total asset value but IV (implied volatility) in DIA calls is so low it might not be worth the effort. In the below chart you will see Dow Jones Index volatility graph compared to Apple's volatility graph. Notice that Dow Jones' volatility typically hands out in mid 10s whereas Apple's volatility hangs out in mid to high 20s.

The fund's future doesn't look bad though. Whether you should stay invested in DIVO totally depends on what your goals are and what your risk tolerance is. If you are looking for a fund that yields about 5%, carries low volatility, grows its dividends year over year, follows Dow Jones Index closely, invests in some of the largest and most influential companies in America (if not the world), if you are not feeling particularly bullish about growth stocks and expect them to be choppy for a while this could be a fund for you to buy and hold forever. If you are more interested in growing your portfolio, matching or beating benchmarks, not worried about volatility, believe that markets will continue their bull run for the foreseeable future, then you might be interested in another fund that is more focused on growth.

It all depends on your risk tolerance and long term goals. I don't expect this fund to outperform major indices during a secular multi-year bull run but again I don't know if we are getting a secular multi-year bull run either considering how stretched current valuations are and how markets have been mostly rallying for close to 15 years with the exception of last year. If I was close to retirement age (or already retired) with low risk tolerance, I wouldn't mind putting stock portion of my portfolio in DIVO but if I was a young worker who is just starting their savings journey, I'd go with something more Nasdaq oriented.

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