PDI - HIPS: This ETF Doesn't Lie In A Favorable Spot Right Now

Summary

• HIPS is an ETF that has the potential to lure investors in with its high yield.
• But this strategy is built for bull markets in high yield bonds. We are not in one.
• In fact, this might be the most dangerous few years for high yield debt since the Global Financial Crisis.
• HIPS has already shown the ability to quickly cut investor positions in half. For us, the yield it offers is not nearly high enough to compensate for that kind of risk.
• HIPS gets a sell rating from us.

By Rob Isbitts

Strategy

GraniteShares HIPS US High Income ETF ( HIPS ) is an ETF that follows a passive, rules-based index, the TFMS HIPS Index. That index invests in up to 60 listed securities (including Closed-End Funds, MLPs, Business Development Companies, and REITs). All holdings are subject to minimum trading liquidity and market capitalization levels, as mandated by the index. What distinguishes HIPS is its focus on securities that must distribute nearly all their earnings to shareholders in the form of cash distributions. So, HIPS stands for High Income Pass Through. And, for those wondering, it has no relation to a popular song by International Music superstar Shakira.

Proprietary ETF Grades

• Offense/Defense: Offense

• Segment: Multi-Asset

• Sub-Segment: Income

• Risk (vs. S&P 500): Similar

Proprietary Technical Ratings

• Short-Term Rating (next 3 months): Sell

• Long-Term Rating (next 12 months): Sell

Holding Analysis

HIPS may, at first glance, appear to be a high-yield bond fund. It does behave a lot like one. But it is really more of an ETF of Closed-End Funds, with additional allocations to a wide variety of other securities that have high yields. Index positions are diversified and structured. About 15 Closed End Funds in roughly equal weightings comprise the top 50% of the ETF. The remaining holdings are a set of 1-2% allocations to everything from Commodity Limited Partnerships, Business Development Companies ('BDCs'), stocks, and REITs. All holdings have above-average yields versus broad stock market indexes and high-quality bond indexes.

Strengths

Markdown HIPS as an innovative ETF, that might just be one to consider...after the next credit bond crisis. It produces a ton of regular income. So, in years like 2019 and 2021, which were relatively smooth sailing for stocks and bonds, HIPS earned a total return of roughly 23% in each case. That was about 3/4 of the S&P 500's return that year. So, like an athlete that is inconsistent, but has their moments, so too does HIPS have the ability to be a key contributor to income-oriented portfolios.

Weaknesses

However, the wind needs to be at HIPS' back in order for that to occur. Its returns have been all over the map since its 2015 inception. That has everything to do with the markets' view of credit conditions. These asset classes thrive when borrowing costs are cheap. This is especially true for Closed-End funds, which apply leverage to turn pedestrian yields into super-sized income returns. But there is a greater chance than not that we have seen the best of credit conditions in the past, and that 2022 ushered in a period where ETFs like HIPS will lure in investors with a high yield, only to expose them to massive price risk.

HIPS also sports a sky-high Expense Ratio of 2.4% and is not a big ETF at about $60mm in AUM. It trades only about $200,000 a day in volume. So it is not very liquid.

Opportunities

When we look at HIPS' 7-year return history through the lens of rolling 1-year returns, it really tells the story. Coming out of a pair of weak periods, both of which were characterized by a sharp drop in high-yield bond prices (2016 and 2020), HIPS rebounded like a triple-levered fund. The ETF does not use leverage at the fund level, but as noted, about half of its holdings are Closed-End Funds, which typically do use leverage to boost yields. So again, the "feast or famine" nature of HIPS shines through.

So, what is the opportunity the next time the market sets up for this (and who knows when that will be)? You can see it above. On those 2 occasions, HIPS rose by 40% and 70% in a single 12-month period, while paying a very high-income yield. Sure, the opportunity is there. But it is a tactical one, not a buy-and-hold consideration for us.

Threats

To truly understand the threat embedded in HIPS, I present below a return chart of the ETF since inception. Three things stand out to me:

1. 7 years, 13.5% total return. Not annualized, cumulative. So, the bad times reverse whatever exciting times there were along the way.

2. 2020 was an outright disaster. HIPS recovered to "only" lose 11.5% for the full year, but only after enduring a 52% decline...in 4 weeks! Feast or famine.

3. During the 7-year tenure of this ETF, if you look only at the price return, it is a cumulative loss of 40%. So, as sweet as that double-digit yield looks (HIPS yields 10.6% as I write this), it does good if you lose a multiple of that on price. It is like the old line about a business that buys $10 bills and sells them to people for $8, and says, "don't worry, we'll make it up in volume!"

Conclusions

ETF Quality Opinion

One of my favorite things about analyzing ETFs for a living is that there are so many undiscovered, under-followed, quirky-but-potentially-effective securities out there. HIPS could be one, but it is truly a "special situation" that might only be useful in short bites, and on occasion. That's why we'll keep it on our watchlist of "Undiscovered ETFs." As we sit here at the start of 2023, I don't see a path to using it in portfolios.

But I've seen stranger things in 3 decades of analyzing ETFs and markets. And when we get that next, inevitable "credit market event" and this ETF is stumbling around with broken HIPS (sorry, I couldn't resist!), it could be akin to buying a washed-out stock, with eyes toward making an outsized return over, say 6-18 months. A contrarian's delight, if you will.

ETF Investment Opinion

But that time is not now. HIPS gets a Sell Rating from us but takes a seat on our watchlist of ETFs to revisit if and when all heck breaks loose in the markets again.

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