2023-08-01 19:18:15 ET
Summary
- The STF Tactical Growth & Income ETF uses a proprietary Tactical Unconstrained Growth Model to allocate between growth equities, treasuries, and money markets.
- The ETF incorporates an option spread strategy to further generate income.
- Like the TUG ETF, the TUGN ETF underperforms the QQQ in both bearish and bullish markets. It further underperforms the TUG due to its spread-writing strategy that trades away upside.
- Definitely a fund to avoid.
As a former fund manager, I am always sceptical when I see funds claiming to use 'proprietary' models to outperform the markets. A few weeks ago, I reviewed the STF Tactical Growth ETF ( TUG ), questioning the fund's Tactical Unconstrained Growth Model, as it appears to underperform in both bullish and bearish markets.
This article reviews the TUG ETF's sibling fund, the STF Tactical Growth & Income ETF ( TUGN ), to see if it suffers from the same issue as the TUG ETF.
Fund Overview
The STF Tactical Growth & Income ETF is an actively managed ETF that uses STF Management's proprietary Tactical Unconstrained Growth Model ("TUG Model") to allocate between growth equities, treasuries, and money markets.
The TUG Model combines quantitative and qualitative factors including asset class and market volatility, rates of change of price and volatility, and correlations between asset classes and volatility. In response to changes in price action, market volatility, and correlations, the fund manager will adjust the fund's portfolio allocation between the equity allocation and the bond allocation to proactively adapt to changing market conditions. For example, when the model identifies the equity markets as being at risk, it will allocate to bonds and / or cash to protect the fund during periodic equity market drawdowns.
The TUG model supposedly avoided 75% of the 40 most volatile days in the past 15 years (Figure 1).
Figure 1 - Illustrative TUG Model signals (TUG whitepaper)
In the manager's opinion, avoiding the most volatile days improve the overall investment experience, allowing investors to stay fully invested for longer.
In addition to the TUG Model, the TUGN ETF also incorporates an option spread writing strategy to generate income. In this strategy, the TUGN ETF will write call options on the Nasdaq 100 Index, while using a portion of the premiums to buy farther out of the money ("OTM") call options on the Nasdaq 100 Index. This strategy is called a 'bear call spread' and it essentially bets that the underlying price will decline or stay below the lower call strike price.
If the underlying price rallies strongly, the bear call spread can cause the TUGN ETF to lose out on price appreciation up to the 2nd call strike price (Figure 2).
Figure 2 - TUGN also employs a bear call spread to generate income (investopedia.com)
Over the long-run, a systemic bear call spread strategy should underperform the underlying asset, as it trades away part of the price upside for premium income.
Portfolio Holdings
Figure 3 shows a partial list of the TUGN ETF's holdings. The TUGN ETF is currently 51.2% invested in stocks, 46.6% invested in short-term treasuries, and 3.6% invested in cash. It has also written an August 2023 15,525/15,975 call spread on the Nasdaq 100 Index.
Figure 3 - TUGN partial holdings list (Author created with TUGN holdings report)
Investors should note that the TUGN ETF invests in the stocks held in the Nasdaq 100 Index, so individual stock positions shown such as Apple Inc. ( AAPL ) represent their position weights within the Nasdaq 100 Index scaled to ~50% exposure.
Returns
The TUGN ETF was only launched in May 2022, so it does not have a lot of performance history for analysis. The TUGN ETF has done well YTD, returning 26.0% to June 30, 2023. However, since inception, the ETF's returns have been more modest, with an annualized return of 2.3% (Figure 4).
Figure 4 - TUGN historical returns (morningstar.com)
The TUGN ETF had a poor 2022, when equity markets and bonds declined at the same time, and the TUGN ETF actually drew down to a 22% loss by late December, before it started to recover as equity markets rebounded (Figure 5).
Figure 5 - TUGN performance (stfm.com)
In fact, if we look at TUGN's historical performance since inception, we can see that the TUGN ETF underperformed both the Invesco QQQ ETF Trust ( QQQ ) (a passive ETF that tracks the Nasdaq 100 Index) and the TUG ETF from inception to December 31, 2022, when stocks and bonds were both declining (Figure 6).
Figure 6 - TUGN vs. TUG and QQQ, Inception to December 31, 2022 (Seeking Alpha)
Furthermore, The TUGN ETF also underperformed the QQQ and TUG ETF from December 31, 2022 to July 31, 2023 when the Nasdaq 100 Index recovered (Figure 5).
Figure 7 - TUGN vs. TUG and QQQ, December 31, 2022 to July 31, 2023 (Seeking Alpha)
So not only does the TUG Model employed by the TUGN ETF underperform the QQQ ETF, as we proved in our prior article, the TUGN ETF further underperforms the TUG ETF in both bullish and bearish markets due to its option spread writing overlay.
Distribution & Yield
Although the TUGN ETF has underperformed, it does have one attractive feature, a generous distribution. The TUGN ETF paid a $2.51 / unit trailing 12 month distribution, which works out to a trailing 11.0% distribution yeld (Figure 8).
Figure 8 - TUGN pays an attractive 11.0% distribution yield (Seeking Alpha)
However, investors are cautioned that the TUGN ETF's distribution is mostly funded out of return of capital ("ROC"), so investors are really just paid back their own capital in the form of the distribution (Figure 9).
Figure 9 - TUGN's distribution is funded from ROC (TUGN annual report)
Conclusion
The STF Tactical Growth & Income ETF claims to employ a proprietary asset allocation model to help investor stay fully invested during bull markets and reduce exposure during bear markets. Like its sibling fund, the STF Tactical Growth ETF, the TUGN ETF uses the TUG Model to determine its asset allocation.
Unfortunately, not only does the TUGN ETF underperform the passive QQQ ETF since inception like its sibling fund, the TUGN ETF further significantly underperforms the TUG ETF in both bearish and bullish phases. In effect, the more financial engineering a product employs, the more it underperforms.
I recommend investors stay clear of the TUGN ETF until there is conclusive evidence its TUG model and option-spread writing strategies add value.
For further details see:
TUGN: A Double Negative Fund To Avoid