NUSI - NUSI: Get Exposure To AI But In A Different Way

2023-09-01 07:33:42 ET

Summary

• NUSI uses a covered call strategy that involves issuing calls while owning the corresponding tech stocks and provides increased income while reducing volatility risk.
• In certain circumstances, it does not deliver the degree of protection expected, as a comparison with the Nasdaq-100-tracking QQQ puts in evidence.
• On the other hand, NUSI has offered better capital preservation than JEPI, another risk-management options-based ETF.
• The strategy is considered conservative and suitable for any stock portfolio but limited profit potential if the Nasdaq rises sharply.
• This thesis aims to show that there is a different way to get exposure to AI.

I became interested in the Nationwide Nasdaq-100 Risk-Managed Income ETF ( NUSI ) as part of my two-pronged strategy aimed at obtaining income while being exposed to big tech like Microsoft (NASDAQ: MSFT ) and Nvidia (NASDAQ: NVDA ), which after the Covid-led digital transformation trend now seems poised to benefit from the AI gold rush. This is an ETF with assets under management of $455 million, whose main holdings and above-7% dividend yield are pictured below.

The ETF uses an options trading strategy that seeks to produce a high level of income by using the Nasdaq-100 Index while shielding investors against downside risks during market volatility, as is common for technology stocks.

The aim of this thesis is to detail this strategy further to eventually show how the ETF can generate income out of the large technology companies that are currently making AI headlines.

AI and NUSI's Option Strategy

Investors can also get exposure to the AI space by investing in the Invesco QQQ Trust (NASDAQ: QQQ ) which comes with assets under management of over $205 billion . Since it tracks the Nasdaq-100, it also holds the same companies as NUSI, namely Nvidia which has seen increased demand for its GPU chips which are used to build OpenAI's ChatGPT. After Microsoft invested billions of dollars in this company, the whole tech ecosystem has now geared up to the AI theme, with Amazon (NASDAQ: AMZN ) adding related capability to its AWS cloud while Alphabet (NASDAQ: GOOG ) trying to popularize its competing chat-based Bard tool. Others like Meta Platforms (NASDAQ: META ) are also boosting engagement with Generative AI resulting in a surge of investor enthusiasm with share prices up by double and triple digits as charted below.

In these conditions, a dose of caution is needed, especially for those who have not invested earlier on and now fear that they can miss out on the rally, and to complicate things, any action by the U.S. Central Bank pointing to further tightening of monetary policy may be volatile for tech.

This is the reason for using an alternative investment strategy with the Nationwide ETF.

It basically sells Nasdaq-100 Index call options to generate a premium as pictured below. Normally, it is the investor who holds securities that he or she then hedges by selling calls but, by choosing the ETF route, this role is assumed by the issuer Nationwide.

Here, the advantage is additional income, while at the same time offering some downside risk protection. This is why it is generally considered a conservative strategy, where the objective is to increase an investor's income from the ownership of their shares. This approach is in sharp contrast to investing in QQQ for capital gains.

It is now time to assess whether NUSI has delivered on the income side and for this purpose, I will use both absolute figures and dividend yields.

Assessing NUSI's Income Flow

As seen by the dividend history chart below, NUSI has delivered on its strategy to pay monthly income as in 2020 and 2021. It is also found that it has paid more than QQQ in absolute terms.

However, a different picture emerges when factoring in the dividend yields, calculated based on the year-end closing share prices of each ETF. Noteworthily, NUSI pays above 7% yields which shows that from the income perspective, it can be said that the strategy put in place by Nationwide to profit from the Nasdaq-100 index has outperformed the gains obtained when owning them through QQQ . Well, you would expect this for an income-focused ETF using an option strategy like NUSI for which you pay an expense ratio of 0.68% compared to only 0.20% for QQQ.

However, NUSI's distributions have trended downwards in 2022, and as per my calculation in the pink table below, dividends for last year totaled $1.6735. The same exercise was done for QQQ, whose quarterly dividend payments have instead totaled $2.1351 for 2022.

NUSI's Behavior During a Market Correction

Hence, the reasons for NUSI's lower distributions in 2022 need to be investigated, and to this end, I plotted a chart of the Nasdaq-100 index.

Now, last year was marked by the Nasdaq-100's downside which was primarily the result of the Federal Reserve being particularly aggressive as to the pace of interest rate hikes. Therefore, based on historical performance, when tech stocks are highly volatile, NUSI cannot be expected to deliver the same level of income (in absolute terms), and it is only because its own share price went lower than the dividend yield went up to 9% as per the pink table above.

On the other hand, if one looks further into the past, namely in 2020 and 2021, where the Nasdaq-100 has delivered net gains for both years as per the above chart, NUSI has delivered more income than QQQ. Noteworthily, 2020 included the Covid-led early Spring market crash as encircled in red above where the Nasdaq-100 cratered by more than 30% . At that time, NUSI's monthly distribution did falter but recovered soon afterward.

Therefore, for risk-averse investors looking for portfolio protection, in case of a market correction, especially after the Nasdaq-100 has surged by around 42% this year, NUSI's dividend will surely take a dent. However, learning from 2020, it should recover soon afterward provided the downside does not last for a long time as in 2022.

Capital Preservation and Comparison with JEPI

Up to now, I have focused on the income potential, but there is also the capital preservation aspect to consider especially when volatility prevails as is presently the case, and expecting a risk-managed ETF to deliver on the capital protection mandate. To this end, I performed a comparison between the YTD price performances of NUSI and QQQ as charted below where it is found that the Nationwide ETF has underperformed its Invesco peer by a large degree, or around 27%.

In consequence, one disadvantage of the option strategy adhered to by NUSI is that, while it does offer capital preservation, the gains can be severely limited if the Nasdaq-100 rises sharply as has been the case this year.

However, the above chart also shows the JPMorgan Equity Premium Income ETF ( JEPI ) which also has a mandate similar to NUSI in seeking to deliver monthly distributable income and equity market exposure with less volatility. It charges fees of 0.35% and its 12-month rolling dividend yield or the total of the twelve most recent non-annualized dividend yields is 10.23% . This is more than NUSI's trailing 12-month yield of 7.18% meaning that you get relatively more income from JEPI.

On the other hand, the Nationwide ETF has provided better protection against volatility, by 12.26% (14.54-2.28) as per the above chart, which is considerable. This is explained by its issuers purchasing Nasdaq-100 Index put options by using a portion of the premium received after selling Nasdaq-100 Index call options.

Discussion

Consequently, Nationwide has put in place additional mechanisms for volatility protection as part of its risk management efforts, which is the reason I invested in the fund. Another reason is to derive income. Third, given current market conditions, NUSI makes sense for those who want to invest in tech, while getting some insulation against volatility. In this respect, some recent economic data pertaining to softer job numbers hint at the possibility of the Federal Reserve exercising a pause, and, on the other, its Chairman has clearly communicated his intention to tighten monetary conditions in order to meet the 2% inflation rate target.

In these circumstances, as seen by the Nasdaq's whipsawing path during the last month in the chart below, you can expect further volatility as other economic data hits the market as the effects of higher interest rates gradually make their way through the monetary system.

Amid this volatility, not all investors can stomach QQQ's high valuations, as with a P/E of 26.31x this is more than 20% of the broader market represented by the SPDR S&P 500 ETF ( SPY ). For those who are more risk-averse, it is important to search for a different way to invest in tech, and NUSI is an alternative with its call option strategy. Here, one advantage of going the ETF route is that the fund managers take care of the options mechanism.

Conclusion

Introducing some caution, especially for tech investors used to invest in QQQ, NUSI may not deliver the same level of capital gains as the Invesco ETF, especially in case of a sharp rise in tech stocks as was seen earlier on. However, it may still be helpful to weather a market correction, somewhat like in 2020, as some of the hype around AI dissipates, but, I do not foresee a 2022-type scenario as artificial intelligence is also about improving productivity.

Finally, as for the price action, currently trading at around $21.26, the ETF is $2.85 above its January 3 low of $18.41. Therefore, its upside has been slow compared to QQQ, and based on the current velocity whereby it has moved by $2.85 in eight months, I expect a price of $22.69 (2.85/8 x 4 + 18.41) by the end of this year. This is only a 6.7% upside and does not merit a buy position, but, NUSI is more about obtaining income out of your tech investments.

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