2023-12-12 13:24:29 ET
Summary
- The Pacer Metaurus US Large Cap Dividend Multiplier 400 ETF offers exposure to dividend futures, making it an intriguing investment opportunity.
- QDPL has a very high expense ratio and invests primarily in a passive portfolio that mimics the S&P 500.
- S&P 500 Dividend Futures contracts represent an interesting structural investment idea.
- QDPL holds short-term S&P 500 dividend futures contracts, which have lower upside potential compared to longer-dated futures.
- I am initiating QDPL with a sell rating as I expect it to underperform the S&P 500 going forward.
The Pacer Metaurus US Large Cap Dividend Multiplier 400 ETF ( QDPL ) represents a highly innovative product as it is one of the only vehicles allowing investors to gain exposure to dividend futures via an ETF.
Dividend futures represent an interesting investment opportunity and thus, at first glance, an ETF that offers exposure to this market segment is intriguing.
However, QDPL suffers from a fatal flaw which is its very high expense ratio coupled with a portfolio which is primarily passive. For this reason, I believe investors should avoid this ETF.
ETF Overview
QDPL seeks to track the performance of the Metaurus US Large Cap Divided Multiplier Index - Series 400. The fund aims to provide cash distributions which are 400% of the S&P 500 ordinary yield with modestly lower exposure to the S&P 500 itself.
QDPL launched in August 2021 and currently has ~$200 million in assets. The fund charges a total expense ratio of 0.79% and has a distribution yield of 6.66%.
Innovative Investment Strategy
QDPL can be broken down into two separate strategies. The first strategy accounts for ~88% of the fund and is simply exposure to the S&P 500. Clearly, this part of the strategy is not innovative.
Where the QDPL story gets more interesting is regarding the other ~12% of the fund. QDPL uses the remaining ~12% of assets as collateral to get exposure to dividend futures. QDPL is not levered since the futures are fully collateralized.
QDPL generally invests in the three most current annual S&P Dividend Futures contracts. In total, QDPL targets dividend exposure that is 4x the level of the S&P 500.
Pacer ETFs
Dividend Futures Present An Attractive Investment Opportunity
Dividend futures tend to present an attractive structural investment opportunity. The reason for this is that investment banks often offer equity-linked structured products to clients with payouts linked to price changes rather than total returns. Thus, if the investment bank decides to hedge exposure with futures or a basket of equities they are left with exposure to movements in dividends.
The dividend futures market allows banks to hedge out any unwanted dividend exposure. Banks are generally sellers of dividend futures while other players such as asset management firms or hedge funds are buyers of dividend futures.
A long position in dividend futures tends to generate positive returns given that it is a risky position with a high correlation to equities. S&P 500 near-term dividend futures tend to have a correlation of ~0.6 with the S&P 500 while longer dated divided futures have a correlation of ~0.7 with the S&P 500.
While dividends tend to rise by ~6% per year, every once in a while there is a major drop due to a sharp recession. For example, the S&P 500 dividend dropped by ~23% in 2009 due to the sharp recession and financial crisis. In 2020, the S&P 500 dividend dropped by ~4% due to the covid-19 recession.
Research conducted by S&P suggests that a buy and hold dividend futures strategy has potential to deliver an annual return of 4%-5%. It should be noted that this level of return is just ~50% of the historical annual S&P 500 return. Thus, dividend futures tend to offer lower risk and lower return profile compared to the S&P 500 itself.
S&P 500 Dividend Futures Term Structure
Currently, the S&P 500 dividend futures term structure is fairly flat which suggests a long position in near dated dividend futures contracts is well positioned to earn a 4%-5% return. For example, the 2024 contract currently is priced at 71.15 which is just 1.3% above the 2023 contract. Thus, if S&P 500 dividends rise by 6% in 2024 the 2024 contract will price will rise by ~4.7%. Further out futures offer even better return potential as further out futures are priced below 2024.
I do not find the return potential very attractive vs short-term treasuries. Investors can currently buy 1 year Treasury bonds yielding ~5.1%. However, I do believe that longer term dividend futures such as the 2029 contract are more appealing. That said, these long-term contracts are not what QDPL holds.
QDPL Holds Short-Dated S&P 500 Dividend Futures Contracts
Currently, QDPL has exposure to short-term S&P 500 Dividend Futures contracts. QDPL has 5.06% notional exposure to the Dec 2023 contract, 5.05% notional exposure to the Dec 2024 contract, and 4.5% notional exposure to the Dec 2025 contract.
The fund will rebalance later this month and the Dec 2023 contract will be rolled into a Dec 2026 contract, which I believe offers better upside compared to the Dec 2024 and Dec 2025 contracts.
High Expense Ratio Is A Strong Detractor
QDPL charges an expense ratio of 0.79%. This is very high and compares to an average equity ETF expense ratio of ~0.16%. The fund's fee strikes me as particularly high given that it is following a rules based index and is not actively managed.
The high fee is especially problematic given that ~85% of the fund is invested in passive S&P 500 exposure. Investors can get access to that exposure via funds such as the Vanguard S&P 500 ETF ( VOO ) which has an expense ratio of just 0.03%. Thus, investors are really paying an expense ratio of ~5.3% on the 15% of the fund which is invested in dividend futures. This level of fee is especially problematic given the relatively low return potential of near-term dividend futures contracts that QDPL invests in.
This is the fatal flow of the product. Even though dividend futures are reasonably attractive on a standalone basis, they are not attractive in the context of a 5.3% annual fee required to obtain the exposure.
Historical Performance
Since its inception in August 2021, QDPL has delivered a total return which is 0.48% less than the total return delivered by S&P 500. This outcome does not surprise me given that the management fee will serve as a small headwind each year.
While QDPL has not trailed the S&P 500 by much thus far, I believe the gap will widen overtime as the S&P 500 rises. QDPL's allocation of 15% to front end dividend futures is a lower risk / lower expected return compared to a 15% allocation to the S&P 500. Thus, over time I expect QDPL to experience some performance drag each year.
Alternative Strategy To Consider
Experienced and sophisticated investors who are interested in trying to take advantage of the structural opportunity related to dividend futures should consider getting direct exposure to longer-dated dividend futures as opposed to obtaining exposure through QDPL which carries a high management fee.
Less sophisticated investors who want to mimic the return profile of QDPL without touching dividend futures should consider investing ~85% in a low fee S&P 500 index product such as VOO and the remaining 15% in a low risk high quality floating rate bond vehicles such the Janus Henderson AAA CLO ETF ( JAAA ) which I recently featured in my piece JAAA: A Great ETF Helping To Level The Playing Field.
Conclusion
QDPL represents an innovative ETF which allows investors to access the dividend futures market in an ETF vehicle.
Dividend futures represent an attractive structural investment opportunity. Near-term dividend futures tend to be lower risk/ lower reward relative to longer dated dividend futures.
QDPL charges a very high management fee for a product that is 85% invested in the S&P 500. As a result, the high management fee is really being paid to manage just 15% of the assets in the dividend futures strategy.
In addition to the management fee headwind, QDPL is also poised to underperform the S&P 500 going forward as near-term dividend futures have less upside potential compared to the S&P 500.
For these reasons, I expect QDPL to underperform the S&P 500 going forward and I am initiating coverage with a sell rating. I would consider upgrading the ETF is the management fee were significantly reduced and strategy was altered to focus more on longer-dated dividend futures which tend to have more upside potential.
For further details see:
QDPL: An Innovative Product With A Flaw