ETF Expert Corner

Recon Capital’s Kevin Kelly Spotlights NASDAQ 100 Covered Call ETF (QYLD)

November 3rd, 2015 by ETF Store Staff

Kevin Kelly, Chief Investment Officer at Recon Capital Partners, spotlights the NASDAQ 100 Covered Call ETF (QYLD) and offers his thoughts on ETF innovation.



Transcript

You can listen to our interview with Kevin Kelly 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 Recon Capital NASDAQ 100 Covered Call ETF. The ticker on that is QYLD. Joining us via phone from New York to discuss this ETF is Kevin Kelly, Chief Investment Officer at Recon Capital. Kevin, thank you for joining us today.

Kevin Kelly: Thanks for having me.

Nate Geraci: Kevin, first, for our listeners who may not be familiar with Recon Capital Partners, tell us a little bit about the firm, along with your general approach to investing.

Kevin Kelly: Recon Capital is a firm that's focused on risk mitigation as well as yield enhancement. We look at all strategies across the board, not only domestically but also internationally. We try to use strategies that are liquid, transparent, and that can be converted to cash on a daily basis.

Nate Geraci: Let's talk about the NASDAQ 100 Covered Call ETF. Again, the ticker symbol is QYLD. This ETF holds the stocks of companies in the NASDAQ 100 Index, which is the 100 largest non-financial US stocks, and then it sells call options on those stocks to generate income. This is what's called a covered call strategy. For people who may not be familiar with this, can you first explain just what a covered call is?

Kevin Kelly: Absolutely. If you look at the ticker symbol QYLD, option yields on the queues. A covered call strategy is a strategy that does that. It generates yields. What a covered call is, you actually own all of the stocks, so you owe them no leverage, and then what you do is you sell somebody the right to buy it from you in the future for a price. That time period can be one month, it can be three months. What we do for this strategy in ETF is we own all 100 constituents in the NASDAQ 100, and then we sell the indexed call option on it on a monthly basis to generate that monthly options premium.

Nate Geraci: Is that the focus here? Is the focus on income, or is there an aspect of risk management? Why sell covered calls?

Kevin Kelly: Covered calls are a very conservative strategy. What it does is two things for investors that are looking for a conservative strategy. It helps reduce the volatility of a portfolio. So this portfolio tracks the BXN Index. That stands for BuyWrite NASDAQ Index. What we saw is that from the period of September 2003 to 2013, it actually lowered the volatility of the portfolio 30% compared to the NASDAQ 100. It dampens and reduces the volatility of portfolios, while at the same time it helps generate additional income in the portfolios. What this can do is this can actually help an investor who's not necessarily looking for 30 or 40% annual returns, but wants to get a nice, steady stream of income.

Nate Geraci: In terms of generating income, what does the potential for income look like with this ETF?

Kevin Kelly: This ETF distributes monthly income. When the option is sold, the next week, the income is declared to be paid out to the shareholders of record. What happens is if we look from December of 2013, when the fund launched, to this previous, this last month, we distributed between 60 basis points and about 1% every month to shareholders. Every time the options are sold against the portfolio, there will be options premium sold out. It is dependent on the volatility of the marketplace. If it's a low volatile month, the options premiums are reduced. If it's a high volatile month, options premiums will increase.

Nate Geraci: Now, if we look at the holdings in QYLD, as we've mentioned this ETF is going to hold every stock found in the NASDAQ 100. Names like Apple, Microsoft, Amazon, Facebook. Then you're simply writing calls on the NASDAQ 100 Index itself. Can you tell us about those calls? How often are they sold? What's the expiration? What's the exercise price?

Kevin Kelly: Absolutely. What's nice to know about this strategy is that you're using a call option in an efficient manner. It uses the indexed call option, which are European natured, meaning that they settle for cash, and they cannot be exercised early. It allows us to efficiently manage the portfolio as well as the cash for the portfolio. It sells it every month, so on the third week of the month, the position from the previous month is closed out, and a new position is written against the portfolio for the next month.

Nate Geraci: Kevin, in what type of market environment should this strategy perform best? I guess also, what's the risk with this strategy compared to just investing in the NASDAQ? Is it missing out on a big upside move?

Kevin Kelly: That's exactly what it will be doing. If you are looking for market exposure, or you just want complete exposure to Apple, Microsoft, Google, Facebook, you should just be invested in those names, or the NASDAQ 100. What this strategy is best meant for is market environments that are 10% or below in annual returns. If you don't think the market's going to go up 15, 20, 30% next year, this could be a strategy to supplement your equity exposure, because we do collect all the dividends paid out by these companies. It's nice that Apple pays a dividend as well as Microsoft pays a dividend, so is Gilead Sciences, which is the top biotech stock in the Index. One of the reasons why we selected the NASDAQ 100 is because these are innovative companies that are growing. We think they are great credit companies that are innovative, they have a lot of cash on their balance sheets. They're perfect names for us to use this collateral to sell call option against.

Jason Lank: Kevin, thanks for being with us today. That last statement, you almost stole my thunder. My question was really, this ETF is based around the NASDAQ 100 instead of perhaps a more widely known index like the S&P 500. Are there any nuances between the NASDAQ 100 and the S&P 500 in terms of your strategy that might be notable?

Kevin Kelly: Yeah. What's notable about this is we wanted to sell an indexed call option, again, names that get higher options premium, and aren't defensive in nature, because that would dampen the portfolios. Because we don't have the defensive sectors necessarily in the NASDAQ 100, we're able to get additional options premium, and names that do perform well. So if you look at Netflix, it is in there, as well as Tesla. You have some great names in there that are growing over the long term, as well as you're not supplanting utilities or other defensive sectors that are in the S&P 500.

Nate Geraci: We're visiting with Kevin Kelly, Chief Investment Officer at Recon Capital Partners. Kevin, before we move on here, where does QYLD fit in a portfolio? Would this replace existing equity exposure? Is this a fixed income replacement? Alternative exposure? How should investors view this ETF?

Kevin Kelly: This ETF is really meant to supplant high income strategies. A lot of times, we see investors coming to us and saying they're using it to replace their high yield fixed income portfolios. They don't want the interest rate exposure, because this doesn't have interest rate or duration risk. As we're starting to see the market anticipate a rise in interest rates over the next couple years, that may have a detriment against fixed income portfolios. So this helps actually remove that duration, or interest rate risk while also still getting that income on a monthly basis. It helps supplant high yields where the corporate credit may not be as good as performers in rising interest rate environment.

Nate Geraci: QYLD isn't the only ETF Recon Capital offers. You do have two other ETFs, the DAX Germany ETF, ticker DAX, which holds 30 German blue-chip stocks. You also have the FTSE 100 ETF, ticker UK, which tracks the 100 largest companies listed on the London Stock Exchange. Tell us about these two ETFs. I'm also curious, what did you see as the opportunity in launching these two ETFs?

Kevin Kelly: One of the biggest opportunities that we saw in launching two of the largest European economies is that Europe is on the rebound, and we're seeing that through the Index performances. The DAX index, if you look over the last month, is actually outperforming the S&P 500, as well as outperforming it over the past year. The Index has done very well, and they are big blue-chip names that are competing against American multi-national corporations, but they're also selling at a discount to their American counterparts just because their zip code is domiciled abroad. If you look at the names in the DAX Index, you can see Bayer, Daimler which makes Mercedes Benz, BMW, SAP which is a big tech name. These are great stable companies that are benefiting from the rebound in Europe, as well as they're growing in China and the United States. The same story happens to be with the FTSE 100. The FTSE 100 is the largest blue-chip names that are listed in the UK, and they've done considerably well, given that ... The Index has done considerably well given its position to benefit from the European rebound as well. Not only that, they actually just got the election behind them, so they've reelected David Cameron, and they have that overhang removed from the market. We saw a big uptick come from the election overhang once he was reelected.

Nate Geraci: Kevin, if I'm the average investor, and I'm looking at both Germany and the UK, you mentioned some of the similarities in terms of the opportunities. Are there any noteworthy differences here if I'm an investor in trying to decide which market or perhaps both to invest in? Are there any notable differences I should be aware of?

Kevin Kelly: There are notable differences. The DAX is a Euro-based economy, as well as they're a manufacturing economy in Germany. They're actually benefiting from the quantitative easing program that is currently being implemented by the ECB. What's also nice to know is that they specialize in industrials as well as health care. Now, when you look over to the United Kingdom, they specialize in financials as well as commodities, so oil, gas, as well as the miners. You have two distinct advantages and different sectors you can play. That's the benefit. One of the things that's also beneficial about both of those countries and the exposures to them is that they actually have a higher yield than the United States. If we go and look at the DAX Index, it's trading at 13 times PE, as well as gives the 3% dividend yield. As we've seen from the earning cycle this season, their actual revenues are growing low to the high teens. That's a great benefit over the US, where we are actually coming off of an earnings recession.

Jason Lank: Kevin, on our show, we've talked quite a bit over the last several years about the merits or lack thereof of currency hedging your investments. Really a two parter here. Number one, are either of these two currencies hedged? Number two, what are your thoughts on hedging and some of the merits or lack thereof?

Kevin Kelly: Neither of these ETFs currently hedge the exposure. The UK has exposure to the pound as well as the DAX has currency exposure to the Euro. We believe over the long term, when you're doing an asset allocation, it's actually beneficial not to currency hedge, especially because you can get that exposure in your domestic market, you're getting that dollar exposure. One of the important things to consider is that a lot of these companies do make earnings in dollars as well, because they are large multinational corporations. What's significant to note is that there is investor demand for currency hedging. Because of that investor demand, we will be launching the currency hedged versions of these ETFs in the first quarter of next year so investors can rotate from currency hedged to un-currency hedged, depending on their views of the currency. We believe if you're an investor and you're not a currency trader, you should just stick to the unhedged version.

Nate Geraci: Kevin, we only have about a minute left here. Quickly, before we let you go, I would love to hear your general thoughts on ETFs as a whole. Earlier in the show, Jason and I went through ETF.com's list of the 15 most important ETFs. One of the main takeaways for us was just the level of institutional caliber strategies that all investors now have access to. I think an ETF like QYLD, that's certainly another example of this. Why is Recon Capital a proponent of the ETF structure?

Kevin Kelly: We're a proponent of the ETF structure because it gives democratization across plenty of strategies. If you look at the ETF space, investors can actually come in and get a covered call strategy at an advantageous price. For 60 basis points, investors don't need to worry about undertaking a potentially expensive or time consuming or complex call writing process, you can get that exposure for 60 basis points through a product like ours, as well as other exposures that they can't get. On the alternative side, or liquid side, there's smart beta, strategic beta. It's a great way for investors to get exposure to strategies that they want at a top advantage price.

Nate Geraci: Well Kevin, we'll have to leave it there. Great spotlight today. We appreciate you joining us.

Kevin Kelly: Great. Thanks so much for having me.

Nate Geraci: That was Kevin Kelly, Chief Investment Officer at Recon Capital Partners, and you can learn more about their ETF lineup by visiting reconfunds.com.