NTSX - HNDL: Avoid Due To High Fees And Complexity

2023-10-26 15:39:32 ET

Summary

• The Strategy Shares Nasdaq 7 Handl Index ETF is a highly complex ETF.
• HNDL has underperformed compared to low fee 60/40 strategies and active ETF asset allocation products which carry low fees.
• HNDL charges a high management fee of 0.96% and is underweight big tech compared to a traditional 60/40 portfolio.
• A reasonable alternative to HNDL is a 23% levered 60/40 portfolio which can be achieved using NTSX, VTI, and BND.

ETF Overview

The Strategy Shares Nasdaq 7 Handl Index ETF ( HNDL ) is an ETF that is designed to seek returns that track the Nasdaq 7HANDL Index. The index is split into two 50% components, a "Core Portfolio" and a "Dorsey Wright Explore Portfolio".

The Core Portfolio includes structural allocations of 30% to U.S. large cap equity ETFs and 70% to U.S. aggregate fixed income ETFs while the Dorsey Wright Explore Portfolio is a tactical allocation within U.S. fixed income, U.S. blend, U.S. equity and U.S. alternative assets.

HNDL has adopted a policy to pay monthly distributions that represent an annualized payout of ~7% of the ETF's NAV on the date of distribution.

HNDL uses leverage and has a structural leverage target equal to 23% of the total portfolio. The fund currently has total net assets of $882 million.

Historical Performance

HNDL has performed very poorly on an inception to date basis. Since inception, HNDL has posted a total return of 11.57% compared to a total return of 35.16% from the Vanguard Balanced Index Fund Inst ( VBIAX ) which represents a low fee 60/40 exposure. I believe VBIAX represents a reasonable benchmark for HNDL given its structure exposure to equities and fixed income.

In addition to underperforming a traditional low fee 60/40 strategy, HNDL has also underperformed active ETF asset allocation products such as the SPDR SSgA Global Allocation ETF ( GAL ) and the iShares Core Moderate Allocation ETF ( AOM ).

High Management Fee

HNDL charges a very high management fee of 0.96%. To put that into context, the average expense ratio for an actively managed equity mutual fund is ~0.66% and the average equity ETF expense ratio is ~0.16%. Comparably, VBIAX has an expense ratio of just 0.07% while GAL and AOM (which are both actively managed ETFs) have expense ratios of 0.35% and 0.20% respectively. As an investor, I work diligently to avoid high management fees (active or passive) as I believe they are often an overlooked headwind when investing.

HNDL's management fee is even more staggering once we consider the fact that essentially 50% of the fund is allocated to a Core Portfolio that is not actively managed. Thus, investors are really paying a management fee of 1.92% on the 50% of fund assets that are truly actively managed via the Dorsey Wright Explore Portfolio in my view.

Holdings Analysis

One of the drawbacks of a complex fund such as HNDL is that it is not always easy to understand holdings and where underweights and overweights truly are vs. a simple 60/40 portfolio.

As shown by the table below, HNDL has ~45% of its market value invested in equities. When adding in the ~90% equity exposure from the 5.4% holdings of the WisdomTree U.S. Efficient Core Fund ETF ( NTSX ) the total equity exposure jumps to 50.3%. This does not account for the additional modest leverage provided via total return swaps.

Within the equity holdings, the biggest active bet that stands out is the large allocation to high yield equities led by the ~7.4% allocated to AMLP as well as 4.1% and 6.6% allocations to SCHH and VIG respectively. While HNDL has exposure to tech through its ~6.9% exposure to the S&P 500 and its 7.1% exposure to QQQ, the fund is still underweight big tech relative to a simple 60/40 portfolio.

To better understand this, let's start by understanding what exposure would be to Apple ( AAPL ) in a traditional 60/40 portfolio. Assuming the 60/40 portfolio uses the Vanguard Total Stock Market Index Fund ETF to get exposure to equities then the AAPL weight would be 60% * 6.05% which gives us a total portfolio level exposure of 3.63% to AAPL.

HNDL gets exposure to AAPL through QQQ, IVV, VOO, SCHX, NTSX, VIG, and JEPI. As shown by the contribution table below, HNDL currently has 2.36% exposure to AAPL (calculation includes an adjustment for leverage as HNDL holds total return swaps to generate leverage to the underlying index).

The takeaway here is that even with a 23% leveraged portfolio, HNDL is still underweight big tech vs. a simple 60/40 portfolio. Using AAPL as a general proxy for big tech exposure suggests HNDL is about 45% underweight big tech. This is a major negative in my opinion as I believe big tech represents an important part of a well-diversified equity portfolio.

The fixed income holdings of HNDL are less controversial in nature as most of the exposure is to the U.S. Aggregate index which is similar exposure as one would get using a traditional 60/40 type portfolio.

An Alternative Approach to Consider

One characteristic of HNDL that I am generally a fan of is the structural use of moderate leverage. Over the long-run equities and long-term government bonds tend to outperform short-term funding sources. Thus, long-term investors can benefit by using leverage.

For investors looking to add structural leverage to the portfolio, I would consider using the WisdomTree U.S. Efficient Core Fund ETF ((NTSX)). NTSX has a net expense ratio of just 0.20% and allows investors to apply ~50% leverage to a traditional 60/40 portfolio resulting in what is close to a 90/60 portfolio. The one caveat to this vehicle is the bond portfolio is made up of U.S. Treasury futures only which means investors in this fund do not get credit exposure.

One approach to consider would be using a mix of NTSX, Vanguard Total Bond Market Index Fund ETF Shares ( BND ), and Vanguard Total Stock Market Index Fund ETF Shares ( VTI ) to construct a portfolio that adds 23% leverage to a 60/40 portfolio. Below are the weights:

NTSX 46% of portfolio.

VTI 32.4% of portfolio.

BND 21.6% of portfolio.

This portfolio provides equity exposure of 73.8% (32.4% from VTI and 41.4% from the 90% equity exposure in NTSX). 73.8% represents 23% leverage to a 60% equity position in a traditional 60/40 portfolio.

This portfolio provides total fixed income exposure of 49.2% (21.6% from BND and 27.6% from the 60% fixed income exposure in NTSX). 49.2% represents 23% leverage to a 40% fixed income position in a traditional 60/40 portfolio.

Taken together, the equity and fixed income exposure of this portfolio totals 123%.

Based on the historical returns of each component shown below (beginning with the inception of NTSX since that launched a few months later than HNDL and assuming no rebalancing for now) the portfolio I suggested above would have returned 35.9% compared to a return of 11.8% delivered by HNDL during the same time period.

Conclusion

HNDL is a relatively high fee and complex ETF. Despite its complexity and high fees, HNDL has failed to outperform even a basic 60/40 portfolio since inception.

I believe the 0.96% management fee that HNDL charges is even higher than it seems as 50% of the ETF is invested in a Core Portfolio which consists of a static 30% exposure to large cap U.S. equities and a 70% exposure to the U.S. Aggregate. Thus ETF holders are really paying a much higher fee on the 50% of assets that are actually managed.

The complexity of HNDL makes it hard to understand current exposures but the fund appears to be underweight big tech by a significant percentage compared to a traditional 60/40 portfolio. This is not a position I agree with as I expect big tech to continue to be a major driver of positive equity returns over time.

Investors who want to employ a strategy with similar leverage to HNDL should consider a portfolio consisting of NTSX, VTI, and BND as a 23% levered 60/40 has significantly outperformed HNDL historically.

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