AGG - HNDL: How To Collect A 7%+ Yield By Investing In This Super ETF

2023-08-11 14:03:21 ET

Summary

• Strategy Shares Nasdaq 7 Handl Index ETF is an ETF of ETFs, providing diversified exposure to various asset classes.
• The fund's investment strategy divides its assets equally between a core portfolio and an explore portfolio.
• Despite a decline in price due to rising interest rates, the fund has consistently met its objective of delivering a 7.0% annual distribution rate.
• HNDL might offer investors an excellent opportunity now that the Federal Reserve is coming to the end of its rate hiking cycle.
• HNDL's fundamentals remain strong, as it delivers excellent returns at relatively low risk for fixed-income investors.

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Thesis

Strategy Shares Nasdaq 7 Handl Index ETF ( HNDL ) is an ETF of ETFs, investing its $1 billion in assets in a collection of 19 ETFs. These 19 ETFs represent a basket of around 20,000 individual securities, providing investors with diversified exposure to treasury and corporate bonds, large cap and high dividend equities, real estate investment trusts (REITs), master limited partnerships (MLPs), and preferred securities. This broad diversification, along with HNDL's commitment to providing investors with a consistent 7% annual yield, makes HNDL a good choice for investors looking to maximize their income. As such, I grade HNDL as a solid buy.

Investment Strategy

HNDL’s investment strategy sees the fund divide its assets equally between a “Core Portfolio” and an “Explore Portfolio.” The Core Portfolio allocates 70% of its shares to US aggregate fixed-income ETFs. Some of these ETFs include the Vanguard Total Bond Market ETF ( BND ) and the iShares Core U.S. Aggregate Bond ETF ( AGG ), which correspond to around 10.7% of the fund’s total assets each.

The remaining 30% of the Core Portfolio’s assets are invested in US large equity ETFs that include Invesco QQQ Trust Series 1 ( QQQ ), Vanguard Dividend Appreciation Index Fund ( VIG ), and Vanguard 500 Index Fund ETF ( VOO ).

On the other hand, the Explore Portfolio will consist of a selection of the largest, least expensive, and most liquid ETFs across 12 different categories. These ETFs provide exposure to dividend-paying stocks and REITs – as well as even more fixed-income securities, including high-yield and investment-grade corporate bonds, mortgage-backed securities, preferred securities, and Build America Bonds.

In many ways, HNDL is a fixed-income ETF that boasts substantial exposure to equities, particularly large-cap dividend-paying stocks, growth stocks, utilities, and REITs. This is all wrapped up in a single product, a single ETF of ETFs, effectively making it a “one-stop solution” for investors looking for broad diversification into US markets.

Core to its investment strategy, however, is HNDL’s objective to deliver a 7.0% annual distribution rate. HNDL has consistently met this target since its inception in 2018. As a primarily fixed-income investment, HNDL pays its 7.0% annual yield monthly.

HNDL Has A Lot Going For It

Since the Federal Reserve began raising interest rates in March 2022, HNDL has lost around 13.55% of its price value. This fall in price is somewhat eased by the high annual distribution rate (7.0%), leading to a total return of -4.49% since March 2022. This isn’t exactly surprising, considering how rising interest rates tend to detrimentally affect bond prices, which HNDL has significant exposure to. With inflation finally cooling and the Federal Reserve continuing to close in on the end of its rate-hiking cycle, the tides may finally be turning in HNDL’s favor – as the value of its bond holdings begins to appreciate. If you believe we’re still headed towards a recession, the outcome remains broadly the same, as the Federal Reserve will need to bring down interest rates sharply to kickstart the economy. Once again, this should substantially boost the value of HNDL's bond holdings.

HNDL also stands to directly benefit from the “AI Boom” through its tech equity holdings in Invesco QQQ Trust Series 1 ((QQQ)) and JPMorgan Equity Premium Income ETF ( JEPI ). JEPI also serves to provide HNDL with some modest second-hand leverage, which helps boost the returns from HNDL’s relatively low-risk approach.

HNDL’s Approach Appears To Be Working

Because HNDL aims to be an alternative to fixed-income investors, it feels appropriate to use the Bloomberg US Aggregate Index as the benchmark. In terms of Total Return Level, HNDL has substantially outperformed the benchmark YTD. Investors with an initial sum of $100,000 saw their investment grow to $109,430 YTD when invested in HNDL. Meanwhile, a $100,000 investment in the Bloomberg US Aggregate Index only grew to $101,890 YTD. HNDL proves that fixed-income investors need not settle for meager returns. Overall, the fund utilizes leverage that’s equal to 23% of the fund’s portfolio.

HNDL has also outperformed First Trust Multi-Asset Diversified Income Index Fund ( MDIV ), another similar “Super ETF” with $420 million in assets under management. Both funds aim to provide investors with a balanced and diversified portfolio in a single holding while also delivering high yields.

In fact, MDIV’s 12-month distribution rate of 6.81% is almost identical to HNDL’s 7.0% annual distribution rate. Despite this, however, MDIV’s total return growth has lagged behind HNDL, growing an initial $100,000 investment to $106,280 YTD, compared to HNDL’s $109,430 total return growth YTD.

HNDL has also managed to outperform the iShares Morningstar Multi-Asset Income ETF ( IYLD ), providing total returns of 7.20% versus 5.27% YTD.

The differences are likely the result of the funds’ differing asset allocations.

Where HNDL’s portfolio keeps a (more or less) balanced fixed-income and US equity portfolio, IYLD leans much more heavily towards fixed-income investments with an 88.18% allocation (as of 07/31/2023).

A Distribution – Not A Dividend

According to Strategy Shares, all or a portion of the distributions received by investors may consist of a return of capital. The table below shows HNDL’s last twelve distributions.

Examining the available notices provided by Strategy Shares for the July 2023 distribution, I found that around 54% of the yield came from a return of capital. Though significant, the portion of yield coming from the return of capital is significantly down from a year earlier, when it stood at approximately 88% in August 2022. Investors should note that the return of capital distributions is not subject to tax. That said, the return of capital can potentially increase the taxable gain when the shares are sold. A return of capital can complicate the picture for retail investors, as it becomes unclear whether the capital invested is actually growing and yielding net profits.

This is where it becomes imperative to use a fund’s total return growth to obtain a better understanding of its performance. HNDL’s total return of 9.43% YTD illustrates that the investment strategy works, delivering a consistent monthly distribution for investors interested in high yield at relatively low-risk.

However, this “one-stop solution” comes at a cost. The fund has a somewhat high net expense ratio of 0.98%, the bulk of which comes from the fund’s management fees.

Concerns About The Fund's Performance

Some analysts have advised prudent investors to avoid HNDL, largely because its total returns moderately underperform other ETFs YTD, like the Vanguard Balanced Index Fund Admiral Shares ( VBIAX ).

While this underperformance is certainly noteworthy, I think it's important to remember that HNDL is a relatively low-risk fixed-income fund primarily designed for retirees. According to Morning Star, HNDL is “moderately conservative,” with a 48.50% allocation towards fixed-income investments and 45.73% towards US equities (as of 08/03/2023). VBIAX, on the other hand, employs a “moderate” investment strategy, with 60.33% and 37.44% of assets allocated towards US equities and fixed-income investments (as of 06/30/2023), respectively.

As mentioned previously, the Federal Reserve has been hiking interest rates since March 2022. As higher rates diminish the value of older, low-yielding treasuries, it's not exactly surprising to find that HNDL's performance suffered through 2022 and 2023. Once interest rates start falling back down, as many expect to happen in 2024, the value of HNDL's fixed-income holdings should appreciate, and investors may find their patience rewarded.

The Federal Reserve’s monetary policy over the last couple of years has also forced HNDL to rely on return of capital to cover a portion of its 7% annual distribution. This might change once interest rates come back down.

However, returns of capital shouldn't be presumed to be bad. Returns of capital can be leveraged by investors to reduce the tax rate to a long-term capital gains rate, defer the taxation until the year of the sale, and may even offer investors some inheritance tax benefits.

Investors can leverage these tax benefits while enjoying a consistent 7% annual distribution, which, I should point out, is higher than the recommended 4% safe withdrawal rate for retirees. While HNDL can keep providing its investors with a 7% annual distribution, the fund only really needs to generate total returns above the 4% safe withdrawal rate to be effective for retirees.

Risk Considerations

In addition to distributions being partially funded by a return of capital, investors should also know that an investment in HNDL carries the risks of all 19 underlying ETFs it holds. Diversification may sometimes protect investors in the event of a market downturn, but this may not necessarily be the case.

Moreover, while the use of a moderate 23% leverage may amplify earnings, it also increases the effects of market volatility. The use of leverage also likely contributes to the fund’s high expense ratio.

Conclusion

Investing for yield is often made needlessly complicated. The reality is that a high-yield portfolio only really needs to do three things. A high-yield portfolio, particularly one suited for retirement, must offer investors a consistent and handsome yield, maintain a stable net asset value over time, and be simple and straightforward enough for investors to get their heads around. HNDL appears to do all that, justifying its somewhat high expense ratio with relatively safe investments, like Treasury and investment grade corporate bonds, with diversification into equities and alternative investments and a little bit of leverage. So far, the strategy appears to work and may work even better when the Federal Reserve’s rate hiking cycle comes to its inevitable conclusion.

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