SCHZ - HNDL: A Moderately Conservative Strategy Begins Its Great Comeback

2023-12-19 10:11:49 ET

Summary

• Strategy Shares Nasdaq 7 HANDL Index ETF is a "fund of funds" that aims to generate returns that can support a 7% annual distribution.
• Since my last review in August, HNDL has posted total returns of +5.22% and will likely continue to outperform due to falling rates.
• HNDL's exposure to equities will amplify returns.
• Comparing HNDL to its peers with a moderately conservative strategy shows how consistently HNDL performs against other funds.

Following +5.22% Returns Since August, I'm Reiterating HNDL's Strong Buy Rating

I last covered Strategy Shares Nasdaq 7 HANDL Index ETF (HNDL) in August . HNDL is a "fund of funds" that invests in a diversified range of ETFs with a 50.55% and 41.71% allocation to fixed-income and equity ETFs, respectively (as of 12/14/23). HNDL is, essentially, a "one-stop shop."

It gives investors a relatively easy way to invest in a basket of 19 ETFs that hold an estimated 20,000 underlying securities.

The fund's objective is to generate returns that can support the generous 7% annual distribution rate, making it a particularly attractive option for fixed-income investors looking to maximise retirement income through higher returns than those typically offered by fixed-income ETFs, including Schwab US Aggregate Bond ETF (SCHZ), iShares Core US Aggregate Bond ETF (AGG), and Vanguard Total Bond Market ETF (BND).

HNDL invests in all three of these ETFs, which make up a combined 32.6% of HNDL's overall holdings (as of 12/14/23).

In August, I gave HNDL a "solid buy" rating despite the fund having posted 3-year total returns of -0.54% due to its exposure to rising interest rates through its bond portfolio. I reasoned then that the fund had performed well for a moderately conservative fund, beating its index, the Bloomberg US Aggregate Index, which posted total returns of -13.63% over the same period.

I also argued that, with interest rates peaking, HNDL's bond portfolio was poised for a significant recovery. Since my review in August, HNDL has managed total returns equal to +5.22% (as of 12/14/23)-once again, outperforming its index and coming close to outperforming the S&P 500.

With all this in mind, I will be reiterating my "Strong Buy" rating.

Why HNDL Will Continue To Perform Well

ETFs with heavy exposure to bonds, like Strategy Shares Nasdaq 7 HANDL Index ETF, are likely to see the value of their bond holdings appreciate significantly in 2024 as interest rates come back down.

The Federal Reserve has more or less confirmed this, indicating on Wednesday that it now plans for three interest rate cuts next year, predicting core inflation to peak at 2.4% in 2024. This is lower than its previous projections back in September of 2.6%. HNDL is uniquely positioned to benefit from falling interest rates through both its bond holdings. With effective maturity of 8.48 years and a yield to maturity of 5.12%, investors can expect healthy returns from the appreciation of HNDL's extensive bond portfolio.

HNDL's equity holdings are also likely to benefit from falling interest rates.

This will be particularly the case for sectors that HNDL is overexposed to compared to its category. Some examples include real estate, which makes up 8.64% of HNDL's equity holdings (versus the category's 5.73%), energy, which makes up 18.78% of HNDL's equity holdings (versus the category's 6.06%), and technology, which makes up 22.06% of HNDL's equity holdings (versus the category's 20.56%). Moreover, HNDL has limited exposure to the financial services sector at just 7.70% (versus the category's 14.06%), which will likely underperform in an environment where rates are falling.

Other Seeking Alpha analysts have correctly pointed out that HNDL has less exposure to large tech companies, like Apple (AAPL), Microsoft (MSFT), and Alphabet ( GOOGL , GOOG ), than a traditional 60/40 portfolio.

However, most often don't mention how HNDL provides similar levels of exposure as one can expect with a 40/60 portfolio. It's worth mentioning that HNDL's exposure to tech giants is higher than other moderately conservative strategies, like iShares Core Conservative Allocation ETF (AOK) and iShares Core Moderate Allocation ETF (AOM). The exposure as a percentage of the total investment is outlined in the table below:

HNDL Is Surprisingly Good At What It Does

According to Morningstar, this is a "moderately conservative" fund.

It, therefore, feels wrong to compare HNDL's performance to "moderate" funds like Vanguard Balanced Index Fund Admiral Shares (VBIAX), as others frequently do. Instead, it's best to think of HNDL as an alternative means for bond investors to amplify their returns in an environment of falling interest rates while enjoying some protection from, or a buffer against, falling equity prices due to an economic and market downturn.

This thesis appears to be further supported by HNDL outperforming the Bloomberg US Aggregate Index nearly five times over since the fund's inception in January 2018. HNDL's YTD total returns of +12.78% (as of 12/16/23) put it ahead of its moderately conservative peers, AOK and AOM, which managed YTD total returns of +9.82% and +11.27%, respectively.

More recently, HNDL has begun to outperform the S&P 500 and VBIAX, posting 1-month total returns of +5.76% compared to the S&P 500's +4.98% and VBIAX's +5.45% (as of 12/16/23).

HNDL's Distribution Now Appears To Be Well Supported Through The Fund's Total Returns

When I last reviewed Strategy Shares Nasdaq 7 HANDL Index ETF, the fund was just about able to cover its target annual distribution with YTD total returns of +7.19% (as of 08/11/23).

HNDL's annual distribution has grown more secure since then, with the YTD total returns increasing from +7.19% (as of 08/11/23) to +12.78% (as of 12/16/23). This positive news makes HNDL one of the better funds in its class of diversified income-focused ETFs. HNDL outperforms both iShares Morningstar Multi-Asset Income ETF (IYLD) and First Trust Multi-Asset Diversified Income Index Fund (MDIV) YTD with a sizeable margin of +2.58% and +2.21%, respectively.

I feel much of the concern about the fund's performance is misplaced.

It's unclear why a moderately conservative fund that's primarily aimed at fixed-income investors hoping to maximise their income through a combination of equity investing and moderate leverage equal to 23% of HNDL's portfolio is having its performance compared to more aggressive strategies. For the right type of investor, HNDL is still a solid choice that performs much better than its peers, like IYLD and MDIV, and even other funds with a similar risk profile, like AOK and AOM.

Risk Considerations

Investors should be aware that HNDL's 7% target distribution may be partially funded by a return of capital. Moreover, as a "fund of funds," HNDL assumes the risks of all 19 ETFs that it holds. Diversification may sometimes protect investors in the event of market downturns, but that may not necessarily be the case. Strictly speaking, HNDL's diversification is only limited to US markets. Investors seeking international exposure should look for an alternative fund or another fund to pair with HNDL.

Conclusion

With all this in mind, I believe HNDL makes for a great investment in the current economic climate. In my previous review, I argued that HNDL's high distributions may allow fixed-income investors to stretch every dollar, maximising their income. I believe HNDL's prospects have improved since then. HNDL's moderately conservative strategy appears to have begun its great comeback. Its extensive equity holdings allow investors to maximise their returns from bonds in an environment of falling interest rates. All the while, HNDL's bond portfolio acts as a hedge against a potential recession.

This strategy makes a lot of sense to me. I believe it's suitable for a great many people, so long as they know that they will be investing in a moderately conservative strategy that's designed to balance risk with returns.

Therefore, it should not come as a shock that HNDL won't make you rich overnight. That said, HNDL will most likely be a consistent and diversified one-stop shop that fulfils its investors' personal investment objectives.

Based on this, I give this fund of funds a "strong buy" grade.

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