DIVO - I Am Buying The Dip In DIVO

2023-05-31 14:18:25 ET

Summary

• DIVO ETF attempts to outperform the market by selling covered calls against only about ~20% of its portfolio, allowing for upside participation and a balance between growth and yield.
• The fund holds dividend-paying stocks with a history of consistent dividend growth, also resulting in a lower tax rate.
• DIVO is designed for patient investors seeking to grow their dividends in a stable and predictable manner without totally sacrificing price appreciation.

Amplify CWP Enhanced Dividend Income ETF ( DIVO ) was one of the star players of 2022 along with JEPI ( JEPI ) as both funds outperformed the overall markets during the bear market which attracted attention of many income seeking investors not only toward these two funds but also towards all covered call funds in general. What sets DIVO apart from other covered call funds is that it sells calls against a small portion of its portfolio and keeps striking a fine balance between growth and yield so it performs on par with the overall market. This is actually pretty rare when you consider that most covered call funds tend to underperform the overall total return of the markets in the long run because they give up all upside for option premiums.

The fund's dividend yield of 4.88% is much lower than many of its competitors which have dividend yields north of 10% but this is fully intentional. DIVO's is actively managed and the fund sells covered calls against only about 20% of its portfolio on any given month. This allows for the fund to participate in much of the upside when the market rises unlike many other covered call funds which give up 100% of their upside for the sake of dividend yield.

This fund only holds about 20-25 stocks and most if not all of these stocks pay dividends and have a history of consistent dividend growth. The fund passes these dividends to investors along with its call premiums so only about half of DIVO's dividends come from covered calls while the rest comes from the actual dividends it receives. There are two advantages to this approach. The first is tax treatment of these dividends. Qualified dividends tend to have a lower tax rate than covered call premiums, which are considered short-term gains no matter what. For example, you could write a covered call 2 years away and hold this position for 2 years, and it would still be considered short-term gain for tax purposes because option trading gains are considered short-term gain for tax purposes regardless of timeline.

The second advantage of DIVO's approach is a rise in dividends over time. Almost every single stock held by DIVO has a long history of raising dividends year after year, including many dividend kings and dividend champions such as Procter & Gamble (PG), Johnson & Johnson (JNJ), McDonald's (MCD) and Home Depot (HD). Every time one of these companies raise their dividends (basically every year) the fund passes these raises to investors. In the below graph, you will see the dividend growth rate of some of DIVO's largest holdings in the last 5 years. Notice that these stocks raised their dividends anywhere from 31% to 111% in the last 5 years.

As a result of this, DIVO also has a history of raising its dividends. In the chart below it may appear that DIVO's dividend took a sharp decline from 2019 to 2020, but it's only because the fund paid a special dividend of $1 per share at the end of 2019 which boosted that year's yield. Otherwise, the fund's dividend payments have been rising since the fund's inception, which means even though its current dividend yield is below its peers, its long term dividend growth will outpace many of them.

If you had bought $10k worth of DIVO at the time of the fund's inception and held until today, you would have doubled your money with annual compounded growth rate ((CAGR)) of 11.81%. Your best year would result in a whopping 25% return while your worst year (last year) would have resulted in a total return of only -3%. It turns out that this fund offers not only solid growth of assets and income but also solid protection during a bear market. Since it sells covered calls against a fraction of its total portfolio, I believe that most of the downside protection came not from covered call premiums but from their excellent selection of stocks.

From an income standpoint, if you had invested $10k into this fund at its inception and held until now while reinvesting dividends, your first year's income would be $453 representing a yield of 4.53% but your last year's income would be $920 which is more than double your initial yield and correspond to a yield of 9.2% over your original investment. This is a good example of the compounding effect also known as the snowball effect.

What if you took a different approach? Instead of investing a lump sum of $10k at the fund's inception, you decided to invest $1k a month into the fund (perhaps as part of your 401k plan). It turns out that your money would have grown tremendously in the last 6 years with your portfolio size reaching $110k from the $1k you started.

Your dividend income would have also grown at a similar fashion from a couple hundred dollars in your first year to almost $5k in your 6th year. This is how retirement plans and long-term income growth portfolios are supposed to work.

In the last 1 year, DIVO underperformed the markets as the market's performance has been almost entirely driven by 6-7 mega cap tech stocks such as Apple (AAPL), Nvidia (NVDA) and Meta (META). Currently, 23 out of DIVO's 25 stock holdings happen to be actually part of the Dow Jones Industrial Index so the fund's long term performance will probably be closer to the performance of the Dow Jones Index than the Nasdaq index. If this would disappoint you, maybe this fund might not be the best place for you to park your money.

The fund doesn't write calls against index funds. Instead it writes calls against its individual stock holdings. Since individual stocks tend to have a higher volatility than indices, this could result in higher option premiums but most of this fund's stocks are low beta stocks with low volatility so its covered call premiums will also be lower accordingly. The fund doesn't specify which stock positions it is writing covered calls against.

On a partially related note, Amplify recently also launched an international version of DIVO with ticker of IDVO. The fund uses a very similar approach to DIVO, but it uses foreign stocks instead of American stocks to accomplish its goals. Some of this fund's biggest holdings include Taiwan Semiconductor (TSM), Petrobras (PBR) and ASML (ASML). While it's too early to talk about this fund's performance, it may be worth a look or at least adding to your watchlist for the time being.

DIVO is mostly designed for patient investors who are not looking for instant gratification (or instant +12% dividend yield) but looking to grow their dividends in a reliable, predictable and stable way without giving up completely on price appreciation in their stocks. When part of a well-diversified portfolio, I think this fund can perform as a solid tool for wealth generation whether you are a young person looking to grow your income over time for your future retirement many years (or decades) away or someone already enjoying their retirement and looking to boost their existing income.

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