Capital preservation is REALLY important... especially to me, since I maintain my cost of living based on capital gains and dividends. I cannot afford to experience large drawdowns... and they're not fun for ANYONE. Sure, you can have diamond hands... but that shit ain't fun. If you've been through it, you know what I'm talking about. That's why, today, I wanted to talk about my top picks for income ETF that preserve capital: NUSI, QRMI, XRMI.
There's none like them in the markets... not that I know of at least. These are more typically found in hedge fund strategies – which I do have allocation to, but more so for absolute returns or long/short strategies, which I'll discuss another time. But, understandably, not everyone has access to those.
So, in my opinion, these are great options for parking cash that can be used to buy the dip or just maintain consistent dividend income. Let's dive into it...
Why these three?
First, treasury bond yields suck... and are giving a negative real rate of return right now, when you factor inflation. So, we need an alternative with the lowest risk/return profile.
So, there are other covered call ETFs – that you may know of – which generating income by selling calls on their holdings... BUT the problem with those, is that the downside isn't protected. So, if we experience a large sell-off or crash in the market... your capital is going down with it. At that point, I don't really care about the yield because I just lost a huge chunk of capital. Forget about buying the dip... that money was supposed to be your safety net. So, for me, those don't work. It's not a risk-off strategy.
This trade-off, just doesn't make sense to me, especially for our objective of capital preservation.
The same goes for business development corporations (BDCs), junk bonds, or other high-yield bonds are all exposed to the same risk. But, if you can capture them at that moment they drop, you can lock in some serious yields... like 50% yields from some good quality BDCs, like Ares (ARCC) and Monroe Capital (MRCC) for example. So, if we were to experience a crash, you can then buy those names... but, of course, you can only do that if you preserved your capital during the crash.
Collared Options Strategy
Assuming you are familiar with the covered call strategy (i.e. selling a call option to generate income and capping your gain), a protective put does the same on the opposite side (i.e. buying a put option to capping the loss on an underlying asset).
All three of these ETFs are applying this strategy on a net-credit basis – which means the premiums received from selling the call option is greater than the premium paid for the put option.
In the case of QRMI and XRMI, they are very specific in that purchase 5% out-of-the-money put options, so the call options are sold very close to or in-the-money. So, the bulk of the income generated is really coming from selling the call options.
With NUSI, however, they're not as clear, but it is clear the strategy is actively-managed – meaning they can adjust the collar strategy as per market conditions, which is superior when you have a good manager. Their options are managed by Harvest Volatility Management, an experienced derivative asset management firm. I like that this is actively managed and outsourced, which makes me feel like it should outperform QRMI and XRMI.
NUSI vs QRMI vs XRMI
Let's compare the three before making our verdict. Before we do anything, however, we have to note that they are all relatively new ETFs, so there is limited history; especially for QRMI and XRMI. It's hard to benchmark them against NUSI or even their respective benchmarks, but we'll do what we can.
QRMI and XRMI, as noted, have only been around since September of 2021 (i.e. less than 4 months of history). This really limits our assessment of performance, yield, and pretty much everything. So, for this reason alone, I feel less comfortable with them... but I won't write them off, I would just allocate less to than relative to NUSI, which has been around since January 2021 (a bit more history).
In terms of distribution yield, here are the current levels:
NUSI – 7.82%
QRMI – 12.28%*
XRMI – 8.99%*
*estimates based on limited distribution history
At first glance, we may be attracted to the higher yield, but consider the things that impact them: (1) their underlying assets (i.e. NASDAQ 100 for NUSI and QRMI versus the S&P 500 for XRMI) and (2) the net credit collar spread, and their options premiums.
If they're using a tighter spread every time, regardless of market conditions, which appears to be the case for QRMI, they can generate a higher yield at the expense of capital preservation. As I mentioned, if you're actively managing this (and assuming you're a good manager) you can adjust the collar depending on which way you think the market will go, and better protect the capital. Based on the limited history, I'm inclined to say that NUSI is doing a better job at this... so if that's the case, I'd be happy to give up a few points of yield or a higher management fee.
You can see the performance of NUSI and QRMI against the NASDAQ below... again, very limited history, but you can see the upside is very limited and the downside protection is something to monitor as we get more history. NUSI alone, has done a pretty good job and seems to be doing well. It's yet to see how QRMI matches up.
The same goes for XRMI, which you can see is following a similar pattern with the S&P 500. Of course, we are investing for yield here, but we just want to see how they perform during events of large drawdowns.
NUSI has an expense ratio of 0.68%, whereas QRMI and XRMI have expense ratios of 0.60%. The difference between them is negligible.
Net Assets Under Management (AUM)
In terms of AUM, with more history, NUSI is the leader with about $660M in net assets. QRMI and XRMI both have about $11.5M – which are significantly smaller. The reason this is relevant, is because of liquidity and lower volume. If, you need to exit your position (and it's large enough) you'll need liquidity. You don't want to be paying a premium to exit if there aren't enough sellers. At QRMI and XRMI's current size, that's a real risk to consider – which is why I wouldn't allocate a whole lot to them. With NUSI, there is less of that risk.
In conclusion, which I hope you got to as well... my preferential allocation is to NUSI. I think it is just the more proven and stable one. That being said, the higher yield in QRMI is attractive, and I have allocated a smaller amount there to test it out. I'll also be testing out XRMI, since it is somewhat less correlated to NUSI, given it is using a different index and basket of assets.
Given the current market environment we're in, I think it's prudent to have a sizeable allocation here to preserve some capital, while having it still work for you at a reasonable yield. That could be anywhere for 20-60%, depending on your viewpoint, total capital, etc.
Hope that helps... let me know if you want more income-generating content. It's nice to think like a boomer sometimes ;)
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