ETF Expert Corner
Amplify CEO Christian Magoon Spotlights Dividend & Option Income ETF (DIVO)
March 14th, 2017 by ETF Store Staff
Christian Magoon, CEO of Amplify ETFs, spotlights the Amplify YieldShares CWP Dividend & Option Income ETF (DIVO) and discusses the longer-term potential of actively managed ETFs as a whole.
You can listen to our interview with Christian Magoon by using the above media player or enjoy a full transcription of the interview below.
Nate Geraci: The ETF we're spotlighting this week is the Amplify YieldShares CWP Dividend and Option Income ETF. The ticker symbol on that is DIVO. Joining us via phone from just outside Chicago to discuss this ETF is the CEO of Amplify ETFs, Christian Magoon. Christian, as always, great to have you on the program.
Christian Magoon: Hey, thanks Nate. Good to be with you and Conor today.
Nate Geraci: Christian, it's clear from the name of this ETF that this is an income-oriented strategy. As a matter of fact, I was looking at the prospectus and it indicates that this ETF seeks to generate between 4 and 7% in gross income annually. Let's just jump right in here. Walk us through the strategy. How is this ETF constructed?
Christian Magoon: Really the genesis of the ETF is a separate managed account and investment strategy that's available to investors at fairly high minimums, and what we did is essentially take that strategy and turn it into an ETF with the advisor Capital Wealth Planning. It's unique in the sense that it's a dividend strategy that also seeks another form of income, not just dividends, but option income. Essentially, the manager, this is an actively managed ETF, is going out and purchasing dividend yielding securities - these are generally large cap, blue chip companies that have sustainable earnings and cash flow. They have to have a history of increasing their dividends. Then, the manager, besides just collecting the dividends from those stocks, actually is opportunistically writing covered calls, when appropriate, to increase the income potential of the fund. DIVO really has two streams of income: traditional dividend income that most investors are used to and then also this other stream which is option premium income via writing covered calls opportunistically. That income, in total, the target is between 4 to 7% a year of income for investors.
Nate Geraci: Christian, for our listeners who may be unfamiliar with a covered call strategy, can you maybe explain this in layman's terms? How does this work?
Christian Magoon: Sure. When you're holding an actual underlying security, one of the more conservative ways of going out and writing an option contract is to write a covered call. Essentially that allows you to collect some premium income, but it does cap your upside should that stock appreciate substantially from where you write that call. It's a way to essentially try to look at stocks that may not potentially have a lot of upside, but instead to kind of capture some additional income or total return by writing that covered call and capturing that premium income. In the case of DIVO, a manager historically has been able to capture about 2 to 4% additional income by writing covered calls against these blue chip stocks that they own in the fund.
Nate Geraci: Now, obviously a covered call strategy can generate some income, but it can also reduce downside risk as well. Can you maybe expand on why that's the case?
Christian Magoon: That's right. If you have the ability to take in that option income, that's another cushion, if you will, to go against a potential decline in the net asset value of the fund or of the individual securities. As we're going to probably see a rise in interest rates this week from the Fed, that's going to negatively impact probably dividend stocks. I think we've already seen a little bit of that happen in the marketplace. To be able to also write some covered calls against some of those dividend stocks and capture several more percentage points potentially of income or cushion can help cushion that downward volatility that we could see in a rising rate environment. You're right, the two benefits really are not only higher current stream of income, and then potentially the ability to have a larger cushion against market volatility. I think that's one of the reasons why DIVO got just recently nominated for active ETF of the year by ETF.com. Quite a unique strategy that allows dividend investors to kind of have that additional income through options, or potentially that downside protection.
Nate Geraci: Christian, give us an idea, what are some of the current top holdings in this ETF and what does the overall sector allocation look like right now? Just at a high level.
Christian Magoon: These companies are really blue chip companies, kind of Dow type companies, so Boeing, United Health Group, Home Depot, Kraft, IBM, 3M. The sector allocation is really designed to be fairly similar to kind of a broad-based benchmark like the Dow Jones Industrial Average. You see consumer discretionary, industrial, technology stocks being amongst the top three sectors that the fund is exposed to. This is really kind of an alternative to buying just a traditional dividend ETF where you own these blue chip names and you collect the dividends. This gives you, again, this additional option to hopefully increase your income potential. As we all know, there's probably not enough income out there for the demand by investors, many who are starting to retire in the baby boomer faze.
Nate Geraci: Again, we're visiting with Christian Magoon, CEO of Amplify ETFs. We're spotlighting the Amplify YieldShares CWP Dividend and Option Income ETF, ticker symbol DIVO. Christian, I've got to tell you, just for full disclosure, we actually spent much of the first part of our program discussing the underperformance of active fund managers. As you mentioned, this is an actively managed ETF. There's a manager attempting to pick individual stocks that might outperform and then tactically write covered calls on those stocks. Now, I know you've seen all the data on active manager underperformance, so the question is what makes this ETF potentially different?
Christian Magoon: I think that's a great observation and I agree. Indexes, by and large, have really crushed active managers. I think what makes this different is that it's very hard to robotically write covered calls. There are funds that do that and they're index-based, but as you know, markets change, conditions change, and you sometimes need to be dynamic in terms of your activity to be able to stay on top of writing covered calls. In fact, if you just have an index that does it once a month, you're likely to really miss out on some opportunities. I think DIVO really, the fact that it's actively managed, is a benefit to investors because a manager can opportunistically go in and write those covered calls throughout the month. It's not locked into what stocks they have to write covered calls on and when. That really allows them to capture these unique income opportunities. I think the stock selection also adds some value. I think some of the basic rules they have in terms of how they select stocks are very index-like. I think you're getting kind of in this ETF a very convenient and tax-efficient way to access an opportunistic covered call strategy that should produce some pretty substantial current income versus a traditional ETF and do it rather tax efficiently.
Nate Geraci: Christian, more broadly speaking, I'm curious as to how you view the potential of actively managed ETFs as a whole moving forward? I've said for a long time that I do think this is a huge potential growth area, especially for old guard mutual fund companies. But if you look at the data at the end of 2016, according to Morningstar, there was less than 30 billion dollars invested in active ETFs. That's compared to more than two-and-a-half trillion dollars in passive ETFs. What do you think it will take for active ETFs to really gain traction?
Christian Magoon: I think part of the issue when you look at active ETFs is how do you define an active ETF? Nate, as you know, many of the indexes that are out there are more active than what most people would think. When you start looking at so-called smart beta, or strategic beta products, that definitely take tilts or use fundamental screens - I think you could argue that they're quasi-active in nature, if not truly active. I think just the traditional manager kind of stock picker ETF, I think is going to be something that probably isn't going to fulfill its promise that many people thought of back in kind of the early days of the possibility for active ETFs. We've seen some great success by Jeff Gundlach, for example, in the fixed income space, but no one's really been able to crack, in a big way, kind of that stock picking, actively managed ETF space. I think it's mostly because many of the great stock pickers, in my opinion, are in the hedge fund world now. They really aren't in the mutual fund land. If they're in the mutual fund land, they don't want to be transparent with their picks, which is an issue currently with the structure of ETFs. I think it's going to be awhile. I do think that some of these unique strategies where there's the need for dynamic activity, or responsiveness, or there's a certain amount of convenience that's offered, like in the DIVO ETF with writing covered calls inside the tax efficient kind of wrapper of an ETF - I think those areas have some potential. But I think for the ETF space, at least in the stock side, there's going to be continued growth of what we call smart beta or strategic beta, kind of the middle ground between traditional indexing and active management.
Nate Geraci: You mentioned the concern that active managers may have with the daily disclosure of holdings that's required by ETFs. I'm just curious, do you think that's a legitimate concern? This fear of potentially being front run?
Christian Magoon: Yeah, I think there's some market moving kind of managers out there that probably have a case to be made there. But the reality is many of these managers are probably disclosing their holdings in separate managed accounts on a daily basis. Jeff Gundlach or Bill Gross, two very high-profile managers, are willing to show their portfolio holdings on a daily basis, granted it's fixed income. There's some different barriers to entry there versus the stock market. I think most managers probably, if they really sat down and thought about it, probably aren't moving markets and probably wouldn't lose their so-called alpha by having kind of end of the day portfolio disclosure in an ETF. It's possible. I mean, we're hearing rumblings that the non-transparent active ETFs may be around the corner, and certainly with a Trump administration, I wouldn't be surprised to see that type of a product roll out here in the next year or so.
Nate Geraci: Do you think there's any potential for that type of product in terms of potentially gathering assets? Do you think that may be a better route to go for active managers?
Christian Magoon: I think maybe from the active manager standpoint it would be a lot more appealing, but it's hard for me to believe the investor would be better served by that. I really think one of the key aspects that often gets overlooked about ETFs is the portfolio transparency they offer. I think portfolio transparency just allows investors to have better asset allocation, information, and it allows them to make decisions that ultimately benefit them in a way that's a lot greater than a non-transparent portfolio. The practice of mutual funds only disclosing their portfolio legally once every quarter is crazy. I wouldn't read the newspaper once every quarter and want to know the news on a daily basis to make my decisions. I think that most investors benefit from the transparency ETFs provide on a daily basis, so I think, boy, for investors going to a non-transparent model, I think that they're getting maybe something that will serve them less, I guess, in their pursuit of better asset allocation decisions.
Nate Geraci: All right, Christian, going back to your transparent ETF, the Amplify YieldShares CWP Dividend and Option Income ETF, just summarize for us, where does this ETF fit in an investor's portfolio?
Christian Magoon: The DIVO ETF is really designed to fit in that area that investors may have for equity income strategies, or dividend paying stocks is another way of saying it. The fund is really designed to provide the dividend income you're used to from blue chip names but, in addition, have a second stream of income that could be another 2 to 4% on top of that traditional dividend stream of income that would allow investors to kind of capitalize on some of the option premiums that are available on these blue chip companies. When you think of a traditional dividend ETF paying 2 to 3% I think is its target, DIVO is seeking to pay out somewhere between 4 and 7%, based off historical numbers. Again, that income coming from both dividends and the ability to write covered calls, when appropriate, based off the manager. The manager's track record for this strategy is in the prospectus of DIVO. That's something that investors can go out and look at. It's a new fund, but again, it's cloned based off an existing investment strategy, one that recently just was given five stars by Morningstar for the separate managed account version. So we're pleased with the ability to provide this in ETF format, and all the efficiencies that ETFs deliver to investors.
Nate Geraci: Christian, about two minutes left here. Even though rates have ticked up over the past several months and we expect the Fed to raise rates again tomorrow, obviously, finding yield has been one of the greatest challenges that investors have faced. Just high level, how do you think investors should think about balancing risk versus return, given where yields are at and where they may be heading?
Christian Magoon: That's I think a great point. Most investors, I think, are always looking for kind of higher yielding securities, and when you look at kind of the yield universe, there are companies that have high yields and then there's companies that are growing their yields, but their yields are quite a bit less generally. We really think it makes sense to balance those two, looking for companies that certainly have high payouts, that fit into an allocation. But just as important, finding companies that have lower payouts, but are growing their payouts. When you're growing your payouts or growing your dividends, those types of companies have the ability to kind of hedge against rising interest rates, rising inflation, and those companies should perform better, be more appealing, in a rising rate environment. I think it's important to not just reach for yield that's been going on for a number of years, and for the most part, investors have benefited because rates haven't risen. But as rates rise, companies that grow their distributions have the ability to hedge against kind of that rising rate risk, and should outperform. One of the key streams in the DIVO ETF is looking at companies that have grown their dividends and that we think is an important aspect to any type of income strategy going forward in a rising rate environment.
Nate Geraci: Well, Christian, with that, we'll have to leave it there. Just a great spotlight today. As always, we appreciate you joining us on the program. Thank you.
Christian Magoon: Thanks for having me, appreciate it.
Nate Geraci: That was Christian Magoon, CEO of Amplify ETFs. Again, the ETF is the Amplify YieldShares CWP Dividend and Option Income ETF, ticker symbol DIVO. You can learn more about this ETF by visiting AmplifyETFs.com.