DFCF - HNDL: A Risky Fund Of Funds With A Targeted 7% Payout Best Avoided

Summary

• HNDL has a balanced equity and fixed income investments portfolio, and has a pre-fixed target rate of payouts, sustainability of which is questionable.
• During the past six months, all of HNDL’s fixed income ETFs failed to generate positive price growth. Price returns of its equity ETFs were not good either.
• Although HNDL’s fixed income portfolio has a high credit rating of AA-, the weighted average yield is too low to sustain a consistent 7% payout.
• HNDL distributes monthly dividends partially out of its capital and has a stated policy that it can modify its distribution rate at any point in time.

~ by Snehasish Chaudhuri, MBA (Finance)

Strategy Shares Nasdaq 7 HANDL Index ETF ( HNDL ) is a fund of funds that invests in various equity ETFs and fixed income ETFs. It has an asset under management of $1.15 billion. The proportion of investments in equity and fixed income securities are almost equal, and all these ETFs invest in the US market. HNDL fully replicates the Nasdaq 7HANDL Index, and has a pre-fixed target rate of declaring dividends, that represents an annualized pay-out of approximately 7% on the fund's per-share net asset value. Annual average total return generated during 2019 and 2021 was a little less than 10%, 9.73% to be precise. The fund has a high expense ratio of 0.78% primarily due to a very high turnover ratio of 119%. It's currently trading at $20.85, almost at par (discount of 0.3 percent) with its NAV.

Strategy Shares Nasdaq 7 HANDL Index ETF Invested in Diversified ETFs

Strategy Shares Nasdaq 7 HANDL Index ETF is a fully diversified fund and seeks to achieve a targeted monthly distribution while maintaining a stable net asset value. With regards to its fixed income portfolio, this "fund of funds" invests in ETFs that deal in investment grade (rated BBB- or higher by S&P) U.S. bonds and other fixed income securities. Investment in fixed income ETFs include Schwab US Aggregate Bond ETF ( SCHZ ), iShares Core US Aggregate Bond ETF ( AGG ), Global X US Preferred ETF ( PFFD ), iShares Broad USD High Yield Corp Bd ETF ( USHY ), iShares MBS ETF ( MBB ), Dimensional Core Fixed Income ETF ( DFCF ), Invesco Taxable Municipal Bond ETF ( BAB ), Vanguard Interm-Term Corp Bd ETF ( VCIT ), and Vanguard Total Bond Market ETF ( BND ).

For the equity portion of its portfolio, it invests in ETFs which invest in stocks of large-cap companies in diversified sectors. More than 65% of its equity investments are in large-cap stocks. Investments were made in a number of well-known equity ETFs such as Invesco QQQ ETF ( QQQ ), Alerian MLP ETF ( AMLP ),Vanguard Dividend Appreciation ETF ( VIG ), Fidelity MSCI Utilities ETF ( FUTY ), Vanguard S&P 500 ETF ( VOO ), JPMorgan Equity Premium Income ETF ( JEPI ), Schwab US Large-Cap ETF ( SCHX ), Schwab US REIT ETF ( SCHH ), WisdomTree U.S. Efficient Core Fund ( NTSX ), and iShares Core S&P 500 ETF ( IVV ). Sectoral distribution of its equity portfolio fails to raise high hopes, as I find less than 40% of the equity portfolio consists of stocks from information technology, industrial, healthcare, and financial sectors.

Performance of Shares NASDAQ 7 HANDL Index ETF Over Past Six Months

During my last coverage I found that HNDL was paying part of its dividend out of its capital. The fund already has a stated policy of distributing monthly dividends partially out of its capital in order to maintain a steady 7% payout. I doubted the sustainability of such high targeted payout due to its policy. The fund has a stated policy that it can modify its distribution rate at any point of time, which makes it a bit risky. That time, I opined that the "fund of funds" failed to generate a positive price growth since its inception and in absence of any price growth, HNDL would lose its attractiveness. Thus, I preferred avoiding any investments in Strategy Shares Nasdaq 7 HANDL Index ETF six months back. I'd like to reassess the investability of this fund of funds.

As HNDL has a high turnover ratio of 119%, performance of its portfolio can only be measured over the short run. During the past six months, the fixed income ETFs performed poorly. Stocks of all fixed income ETFs failed to generate positive price growth. Price returns of equity ETFs were not good either. AMLP and VIG grew by 4.63% and 2.66%, respectively. All other equity ETFs generated negative price growth over this period. As a result, HNDL also generated a negative price growth 5.9%. HNDL generated a strong annual average total return during 2019 and 2021, but failed to create a positive total return during the past six months, despite such a high yield of 7.25 percent. Six month total return was a little more than negative 3%.

Investment Thesis

Strategy Shares Nasdaq 7 HANDL Index ETF has an AUM in excess of $1 billion. However, for a "fund of funds," this is not an exceptionally high amount. HNDL has a balanced equity and fixed income investments portfolio, and has a pre-fixed target rate of declaring dividends. Although 7% annualized payout is quite strong, the sustainability is questionable. The fund distributes monthly dividends partially out of its capital and has a stated policy that it can modify its distribution rate at any point of time. During the past six months, all of HNDL's fixed income ETFs failed to generate positive price growth. Price returns of equity ETFs were not good either. As a result, HNDL also generated a negative price growth 5.9%, and total return of minus 3%.

Sectoral distribution of HNDL's equity portfolio also fails to raise optimism, as investments in stocks from information technology, industrial, healthcare, and financial sectors is relatively lower than most diversified equity ETFs. These sectors, in my opinion, are having the highest growth potential. Although the fixed income portfolio has a high credit rating of AA-, the weighted average yield is too low to sustain a consistent 7% pay-out without any capital erosion. I don't find any strong rationale for investing in Strategy Shares Nasdaq 7 HANDL Index ETF for a shorter period. And because HNDL has a high turnover ratio, taking a long-term view in this fund is quite difficult. Even if I plan to invest over the long run, I'd prefer to pick some individual ETFs that this fund invests in, rather than invest in this "fund of funds."

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