ICAP - ICAP: Strong 9.3% Yield Risky Holdings High Expenses

2023-04-21 00:26:06 ET

Summary

• ICAP is a U.S. dividend equity ETF.
• It offers a whopping 9.3% yield.
• Risks abound.

Author's note: This article was released to CEF/ETF Income Laboratory members on March 30th.

A reader asked for my thoughts on the InfraCap Equity Income Fund ETF ( ICAP ), an actively-managed ETF focusing on high-yield U.S. equities.

ICAP offers investors a strong, growing 9.3% dividend yield, much higher than those of its peers. On the other hand, the fund's holdings are riskier than average and its 0.80% expense ratio is much higher than average. Expensive funds tend to underperform, and I believe that will be the case for ICAP moving forward. As such, I would not invest in the fund.

ICAP - Overview and Benefits

ICAP is an actively-managed ETF focusing on high-yield U.S. equities.

The fund has a reasonable amount of industry and holding diversification, with investments in most relevant industries. The fund is overweight financials, including regional banks, real estate, including mREITs, and pipelines, including MLPs, due to their strong yields. The fund does invest in other industries and companies, including large-cap dividend stocks like Coca-Cola ( KO ) and AT&T ( T ).

ICAP focuses on high-yield stocks, which results in a strong 9.3% dividend yield for the fund. Said yield seems to be covered by underlying generation of income right now , as evidenced by the fund's 9.9% SEC yield (the gap is due to recent changes in share prices and yields). Due to recent regional bank weakness, fund dividends are a bit less safe than implied by these figures, in my opinion at least.

ICAP's dividend growth track-record is reasonably good. Dividends have grown around 3.0% since inception, in very late 2021, and there was a sizable special distribution in late 2022 as well. Dividends are quite stable too, in part due to the fund's distribution policy. Stable, growing, strong dividends are quite rare, and incredibly beneficial for investors.

ICAP's dividends are very compelling, and do make for a reasonably compelling investment thesis. There are, however, several important negatives to the fund that investors need to consider. Let's have a look at these.

ICAP - Negatives

Risky Holdings

ICAP focuses on stocks with very high yields which, almost by definition, are incredibly risky. The fund's energy investments are exposed to volatile energy prices, and suffer from declining earnings and share prices when these go down. ICAP's mREITs are (sometimes) excessively leveraged, and suffer outsized losses when asset prices decline. The fund's regional bank investments are a bit riskier than average, and some have seen balance sheet damage as rates rise.

In my opinion, ICAP's risky holdings are likely to experience above-average losses during bear markets and recessions. This was not the case in the 2022 bear market, as energy outperformed that year. Still, I believe the fund is likelier than not to underperform during any future bear market or recession.

As ICAP is a relatively young fund, created in late 2021, I can't really gauge its performance during the last recession, in early 2020. Still, most dividend ETFs underperformed at the time, as did ICAP's most important overweight positions.

ICAP focuses quite heavily on several niche asset classes, which makes the fund overly reliant on these for its performance and returns. Meaning, an energy price crunch would have a greater impact on ICAP relative to the S&P 500 or most large-cap equity funds, as would issues in the mortgage or regional banking industry. Expect significant losses or underperformance if any of these post sizable losses, as has been the case YTD for regional banks.

Regional banks might not be excessively risky, but by overweighting said industry, the fund depends on said industry performing well, which is not really the case for most broad-based equity index funds. As an example, the S&P 500 includes many financials, even First Republic ( FRC ), one of the worst-performing regional banks of the year. Nevertheless, the S&P 500 has performed quite well all year, as the index includes many industries and securities, and so can withstand localized losses much better than ICAP. First Republic crashing was not a significant issue for the S&P 500, while the same is not true for ICAP and its regional bank holdings.

Although I'm not expecting another bank crisis anytime soon, ICAP remains heavily invested in many niche sub-asset classes, exposing investors to significant losses from issues in any of these.

High Expenses

ICAP is a relatively expensive fund, with a 0.80% expense ratio. Expenses are significantly higher than average, with most equity index funds / dividend equity funds sporting expense ratios lower than 0.10%. Even retail-favorite JPMorgan Equity Premium Income ETF ( JEPI ) only costs 0.35%, and JEPI has to manage an active stock portfolio and ETNs. ICAP is much more expensive than average, to the detriment of its investors.

I have two issues with ICAP's expenses.

First, is the simple fact that these directly detract from the fund's performance, and make overperformance difficult. Generating alpha is difficult enough, generating +1.0% in alpha consistently throughout the years is extremely difficult, but that is what ICAP needs to do to outperform given its expenses. Very few funds manage to do this, and I don't expect ICAP to be one of the few.

For reference, Morningstar calculates the percentage of funds which outperform their benchmark by asset class and expenses. Expensive funds rarely outperform. For U.S. mid value funds, ICAP's closest benchmark, they never do.

Second issue I have with ICAP's expenses, is the fact that peer expenses are much lower, so investors can easily avoid them. The SPDR S&P 500 Trust ETF ( SPY ) costs 0.09%. If SPY's 1.6% dividend is too low the Schwab U.S. Dividend Equity ETF ( SCHD ) yields a respectable 3.6%, and costs 0.06%. If the yield on that is too low, JEPI yields 11.3% and costs 0.35%. Regional banking, pipeline, and mREIT ETFs are cheaper too. I see no reason to overpay for ICAP, so I would simply not do so.

Although ICAP's risks have been much more detrimental to the fund's performance than its expenses, it's the latter I'm most concerned about. Risks might not materialize in the future, but investors will pay excessive fees regardless.

As a final point, my concerns about ICAP are almost entirely long-term issues. Expenses would almost certainly not matter if conditions and sentiment in the regional banking or oil industry were to improve, which is always a distinct possibility. Expenses will almost certainly matter for long-term holders of the fund, however.

ICAP - Quick Performance Track-Record

ICAP's performance track-record is below average. The fund was performing in-line with its dividend peers until last month, and then crashed due to liquidity and solvency issues in the regional banking industry. After the crash, the fund is quite a bit behind its dividend peers, but only slightly behind the S&P 500.

In general terms, I don't consider ICAP's track-record to be terrible , as the fund has really only underperformed for around two months. Still, I see some negatives, and no positives, here.

Conclusion

ICAP is an actively-managed high-yield U.S. equities ETF. I would not invest in the fund due to its high 0.80% expense ratio and risky holdings.

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