With around 10,000 baby boomers retiring in the US every day, the investment industry is always trotting out the latest and greatest investment offerings to help retirees solve the following riddle: How do I turn my accumulated savings into consistent retirement income?
Strategy Shares Nasdaq 7HANDL Index ETF (HNDL) is the latest offering attempting to solve this riddle.
The fund aims to generate a consistent 7% annual distribution to its shareholders. 7%! A figure that dwarfs the current yields of most fixed interest or dividend focused investment vehicles. 7% also exceeds most academic “safe withdrawal rates” by a wide margin.
“What’s unique is the 7% target distribution,” said David Miller, HNDL’s portfolio manager. “As opposed to just owning a diversified portfolio, investors wouldn’t have to go to the effort to sell part of their holdings to generate what they would get from the distributions.”
As soon as I saw this new offering come across my desk, I knew I had to talk about it because I figured our listeners would be emailing me for my opinion sooner rather than later!
Under the hood:
The Nasdaq 7 HANDL is split 50/50 into an income component and a core component.
The income generating portion invests across 12 indexes, featuring MLPs, preferred stocks, utilities, covered calls, REITs, etc.
The core portfolio provides exposure to the US equity and fixed income universe with a 70% bonds and 30% stocks allocation.
That’s about 85% of the fund generating income for distributions.
85% of the portfolio is tasked with generating our monthly income, with the stated goal of hitting 7% annually.
Let’s look at the yield of some of the individual components to see how difficult this task might be:
Vanguard’s Real Estate ETF, VNQ, has a 12 month yield of 3.48% according to Morningstar.
Vanguard’s Utility ETF, VPU, has a 12 month yield of 3.17% according to Morningstar.
Both of those investments offer decent yield, both offer higher yield than treasuries in order to compensate us for accepting additional risk and volatility, but neither investment is even close to the funds 7% target.
So what gives?
Two things: leverage and return of principle.
The funds attempts to boost return by using leverage. Not a lot of leverage – To be exact, this fund uses 23% leverage in an attempt to boost its returns.
David Cohen is the co-founder of this fund, and he has this to say about leverage: “We don’t like to talk about the leverage part, because it upsets people,” said Cohen, “But leverage can be your friend. Take a low-risk portfolio and leverage it up to a level of risk you’re interested in taking, and you have a better overall investment experience.”
That quote provides the main take-away I’d like to pass on to retirees or anyone else thinking about investing in this fund. The only way to increase returns in a low interest rate environment is to increase the risk (and thus possibility of loss) in your portfolio. There are no free lunches in investing, higher return equals higher risk.
I think investors are going to be drawn to the 7% income promise and that is probably by design. How many retirees will ignore the additional risk of using leverage to attempt that high withdrawal rate? That remains to be seen.
I can’t tell you how many investors I’ve visited with in my career that thought they had low risk real estate investment, only to find out the hard way how much risk they were actually taking. In June 2018, the yield on the US 10 year Treasury is just under 3%. Any investment yielding more that that is taking more risk than the risk
So Leverage is #1, #2 is return of capital,
From the Q1 2018 fact sheet: Shareholders should not assume that the source of a distribution from the Fund is net profit. Shareholders should note that return of capital will reduce the tax basis of their shares and potentially increase the taxable gain, if any, upon disposition of their shares.
The distribution is not a dividend. – All or part of the distribution may consist of a return of capital. – Just like traditional portfolio withdrawals in retirement.
That’s the overview of the newest retirement investment cure-all that passed across my desk, the question is: What do I think? Is this a sound strategy for the average retiree?
Short answer: no.
The overarching reason this investment won’t be the cure-all for most retirees is because If you want 7% from your portfolio you’d have to invest 100% in this fund.
This doesn’t work in the real world because if we use 100% of our portfolio to generate yield, we don’t have anything left for long-term growth. Long-term growth is what is going to grow our retirement portfolio over time – allowing for vital increases in portfolio withdrawals in order to properly keep up with inflation.
Compare that idea to a standard 60/40 stock/bond split – the 40% is bonds and cash, not meant to cover 100% of your retirement distributions with dividends and interest, but to provide enough non-stock retirement runway to allow the 60% allocation of stock to attempt long-term growth and benefit from compound interest. Live on the 40, grow the 60, rebalance once you drift away from your modeled tolerances.
Using 100% of your portfolio to meet your income needs through dividends and interest might work great in the short term, but after a few years, once inflation starts to catch up with you, you’ll find yourself needing growth, and there won’t be any to tap in to.
Just a reminder – don’t take my commentary as a recommendation for or against purchasing this specific investment product – Unless you are already a client of mine, I don’t know the unique circumstances of your financial situation, and thus can not – morally or legally – give you investment advice.
Credit for post title goes to: https://twitter.com/TFMkts
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