ETF industry veteran and renowned author and speaker Christian Magoon is back on the product development front after dedicating several years to his consulting business, Magoon Capital. This time around, Christian Magoon is looking to make an even bigger splash in the ETF universe with the founding of YieldShares LLC, an ETF Sponsor focused on income-oriented products. Magoon recently took time to talk about his firm’s offering, which is aimed at quenching the yield appetite of income-starved investors; meet the High Income ETF (YYY) [see 101 High Yielding ETFs For Every Dividend Investor].
ETF Database (ETFdb): What motivated you to return to the ETF product front and work on the YieldShares High Income ETF (YYY)?
Christian Magoon (CM): Many investors face the daunting challenge of generating material investment income in today’s low interest rate environment. I wanted to make a significant difference in the portfolios and lives of income investors such as retirees. I felt smart, diversified access to closed end funds through an ETF was an overlooked income solution.
YYY’s distribution yield of 9.32% as of September, 13 2013, displays evidence that the investment strategy underlying YYY has significant potential to be a tool for investors to meet their income needs.
ETFdb: What is the methodology behind YYY and how does it actually work?
CM: The underlying benchmark for YYY is the ISE High Income Index. The index is designed to produce a high current level of income by investing in secondary closed-end funds (CEF) with two important characteristics: high distributions and significant discounts to net asset value.
The methodology begins by excluding CEFs with less than $500 million in market cap and $1 million dollars in average daily trading volume over the last six months. These two screens increase the liquidity of the CEF universe being considered. The remaining funds are then ranked by three individual criteria: distribution size (high to low), discount to net asset value (high to low) and liquidity (high to low).
The result is an index consisting of the overall top 30 CEFs ranked by the above criteria. The highest ranked CEFs in the index receive a higher weighting with a cap of 4.25 percent. The index is reconstituted at the end of each calendar year.
ETFdb: What is compelling about investing in CEFs considering that they are a dying breed?
CM: First, investing in CEFs trading in the secondary market offers an opportunity that traditional mutual funds and ETFs don’t offer – the potential to buy shares of the CEF at significant discounts to the net asset value of the shares. The opportunity to purchase assets at a discount increases an investor’s ability to generate income. In addition, buying at a discount has the potential to provide a cushion in downturns or a measure of capital appreciation in upturns [see our Monthly Dividend ETFdb Portfolio].
For example, in the last 10 years (ending April 30, 2013), the average CEF traded at a 3.85 percent discount to net asset value. This means that $1 worth of fund assets from asset managers, including PIMCO, BlackRock and Eaton Vance, could be purchased for about 97 cents. As a point of reference, the average CEF discount in YYY as of the August 9, 2013 was (7.67) percent or 93 cents on the dollar.
Second, the CEF market is in growth mode. In the first half of 2013 there were 18 IPOs with $12.6 billion raised, whereas 2012 saw 23 IPOs with $11.9 billion raised over the course of the year. Both 2012 and 2013 numbers especially bode well in comparison to the total asset size of the CEF industry, which was $265 billion at the beginning of the year. With that being said, YYY does not purchase CEFs at the IPO level, but instead owns CEFs after the IPO sales charge has been taken out, and the CEFs are trading on the open market. Because of this growth, we could expect to see a continuance in investment opportunities for the foreseeable future.
ETFdb: Aside from generating income in the current low-rate environment, what else might investors find appealing about adding YYY to their portfolios?
CM: YYY has three other important characteristics in addition to being an ETF with a distribution yield of more than 9 percent. First, the effective duration, or sensitivity to interest rates, of YYY’s portfolio is low. At one and a half years, this duration compares to short-term bonds, which have significantly less income potential.
Second, YYY offers a surprising amount of equity exposure for the average income investor. About 59 percent of YYY’s portfolio is invested in equity CEFs. These funds tend to either own dividend stocks and/or employ an active covered call strategy to produce high current income. This strong equity tilt may be a diversifier to a traditional income-oriented investor focused on bonds.
Finally, YYY offers one-stop exposure to various income investment strategies, asset classes and asset managers. For many investors, this basket would be expensive to compile and difficult to monitor on their own. YYY delivers efficient and convenient access to this group of CEFs which is selected based on a defined investment strategy.
Bottom Line: Recent Fed taper talks have brought back investors’ focus to the historically ultra-low rate environment; although monetary tightening is now on the horizon, many continue to face a serious challenge when it comes to generating a meaningful stream of income from their portfolios. As such, the recently launched YYY warrants a closer look from anyone looking to beef up their dividend income, as this ETF is designed to deliver a meaningful yield through a unique investment approach focused on the closed-end funds (CEFs) space.
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Disclosure: No positions at time of writing.