After a sustained stretch of escalations, the U.S. Federal Reserve has placed a hold on its trajectory of interest rate hikes. It has maintained the status quo on the federal funds rate without changes since July 2023. Investors anticipate a rate reduction in May, which diverges from earlier projections of March made at the year's start. As a result, credit markets are recalibrating to this shift.
The 10-year U.S. Treasury yield surpassed 5% in October last year. The soaring yield on long-term bonds had negatively impacted stocks – most significantly those of dividend stocks. Nonetheless, the surge was decidedly unsustainable.
The 10-year Treasury yield dipped below 4% for the first time in approximately two weeks as investors anticipated the latest interest rate policy and monetary directives from the Fed. Treasuries are often the safe haven for investors in times of perceived impending concerns, and the recent withdrawal from bank stocks could be inducing flashbacks of the banking crisis experienced last spring.
Moreover, a gradual cooling within the labor market was recently revealed, which was evident from the employment cost index and the ADP payrolls report. These indicators further catalyze market optimism concerning a potential interest rate cut by the Fed, which could further lower yields.
Lastly, the Treasury Department’s quarterly refunding report indicates that the supply of longer-term bonds is unlikely to exceed expectations. A limited supply assuages concerns about the market’s capacity for debt absorption and pushes yields in a downward direction.
Simultaneously, investors eagerly watch for insights into the Fed's strategy for halting the drawdown of its balance sheet, a process dubbed quantitative tightening. Approximately $1.3 trillion in bonds has been eliminated from the Fed's balance sheet, which peaked near $9 trillion in mid-2022, leading to overall liquidity contraction in the market. Many in markets have been expecting the central bank to wind down quantitative tightening this year.
Given this backdrop, investors are increasingly turning their focus toward high-dividend ETFs in their quest for profitable, reliable income streams and diversification.
Amplify High Income ETF (YYY) is a specialty ETF that's known as a "fund of funds". Rather than purchasing individual stocks, bonds, or REITs or engaging in the selling of covered calls like many other ETFs, YYY operates by investing in and holding other income-generating funds. It aims to amass dividends from these funds and then distribute them to its shareholders. YYY has been operational since 2013, and since then, it has succeeded in drawing significant investment capital.
YYY operates by creating a portfolio of closed-end funds (CEFs) based on a rules-based index. The selection of holdings is driven by quantitative metrics, which allows for a certain degree of objectivity in investment decision-making as it eliminates some human element. YYY's sophisticated algorithmic system is programmed to pinpoint the most lucrative CEFs that meet three important criteria – yield, liquidity, and discount to net asset value (NAV).
This strategy has been beneficial so far, as demonstrated by the fund's impressive current yield of 12.4%. Acquiring ETFs below their NAV is considered a discount. There is scope for capital appreciation if the CEFs under YYY's portfolio manage to reduce their discounts to NAV. As of January 31, 2024, YYY had an average CEF discount of 8.20%, which suggests that YYY's market pricing was more economical compared to the NAV of its underlying CEFs, indicating a potential value proposition for investors.
As of January 31, YYY reported $428.22 million in Assets Under Management (AUM) and an NAV of $11.78. The ETF also seeks to deliver high monthly income to its investors. YYY boasted a distribution rate of 12.41% and a 30-day SEC yield of 10.58% as of January 31, 2024. This is notably higher than the yield on a 10-year treasury bond, underscoring YYY's efficacy as a high-yield investment mechanism.
Its net inflows were $92.28 million over the past year and $50.62 million over the past six months.
Moreover, YYY has gained 12.3% over the past three months and 1.2% over the past month to close the last trading session at $11.76.
YYY maintains a diversified stance, holding 45 different positions, with its top 10 holdings contributing to 32.1% of the entire assets.
No single holdings exceed the 3.62% that PIMCO Dynamic Income Fund (PDI) accounts for. The amassed holdings mostly emerge from esteemed investment firms' CEFs, including the Eagle Point Credit Company (ECC) with 3.46% of the weightage in the fund and Oxford Lane Cap Corp. (OXLC) at 3.45%. Though the top holdings like PDI and OXLC offer alluring dividend yields, their performance over the preceding decade was underwhelming.
While YYY's diversified nature and attractive yield, complemented by a portfolio trading at a discount to NAV, present an enticing proposition, it should be considered that the fund constitutes other funds imposing their fees. Hence, its expense ratio is relatively high, standing at 2.72% against the category average of 0.91%.
Given that it holds CEFs, which levy their management fees, YYY also incorporates "acquired fund fees" of 2.22%. With the addition of YYY's own 0.5% management fee, one is looking at a total of 2.72% management fee.
Investor interest is frequently piqued by ETFs like YYY, boasting exceptional dividend yields. Currently offering an enticing 12.4% yield, YYY does possess a few redeeming features. However, investors need to look under the hood before endorsing any commitments to this sort of ETF.
CEFs often encounter a 10% or greater disparity to NAV, and while YYY’s bundle of CEFs trading at an 8.2% dip to NAV might appear attractive, there's no guarantee of shrinkage in this gap. Investment giant Fidelity stresses that “a CEF’s discount or premium tends to persist. If the CEF typically trades at a large discount, it will tend to stay at a large discount, barring any corporate actions from the board of directors.”
Hence, although NAV discounts potentially generate value, lacking a definitive catalyst, this discount may remain.
CEFs are actively managed and thus tend to incur higher fees and regularly employ leverage to augment returns, which simultaneously amplifies risk. Consequently, YYY's substantial fee poses a significant disadvantage, accumulating over time.
These elevated costs might be justifiable if YYY was significantly outstripping the broader market. Its impressive 12.4% yield may suggest thriving returns; sadly, long-term performance paints a different picture. YYY experienced a one-year total price return of negative 7.4%. Over the past two years, its total return plummeted by 25.8%. Although 2022 proved difficult across the market, pardoning YYY that particular year. However, over a five-year period, its returns still fell by 32.6%.
Despite providing investors with dividend gains in this timeframe, YYY substantially trails the broader market. For instance, the SPDR S&P 500 ETF Trust (SPY), an accurate S&P 500 representation, advanced by 78.9% in the same five-year duration while only levying a 0.09% fee. Similarly, the Invesco QQQ Trust ETF (QQQ), investing widely in the Nasdaq 100, yielded 148.1% over the identical timeframe with a nominal 0.2% fee.
Choosing investment strategies like SPY or QQQ could have significantly boosted potential earnings, thus creating a substantial opportunity cost.
Summing up, YYY holds appealing elements, such as its high yield and portfolio’s NAV discount, but it would be wise if investors proceed with caution and wait for a more favorable entry point in this ETF.