Why ETF's are risky for income hunters

Why ETF's are risky for income hunters

In a low interest rate environment, the holy grail of investing is income. This is especially the case for investors nearing or in retirement, many of whom are looking at exchange-traded funds (ETF’s) as one answer.

Some would have you believe ETFs are one of the best ways for investors to generate income from the share market without taking on substantial risk. In reality this couldn’t be further from the truth.

Don’t be fooled. The fact is that with all share market investments, including income generating investments, there is a risk to the investor’s capital, including ETFs. I would go as far as to say there is probably greater risk to capital in ETF’s due to the passive nature of their management, meaning they generally hold a portfolio shares and are unable to move to cash. If the market falls and your ETF is say exposed to the largest 20 shares in the market, then there is a greater risk of capital loss not only due to market risk but also concentration risk as opposed to a more active approach, particularly during times of elevated volatility.

The buy write strategy is a popular and effective way of generating enhanced income from shares however by its very nature the strategy is an active approach. The Beta Shares Ymax ETF is one such product that undertakes the buy write strategy. However in my opinion the ETF structure reduces the effectiveness of the buy write strategy where by investors should be seeking an exercised return on a monthly basis, not just the income return generated from the call premium received.

The exercised return not only provides a larger return on a monthly basis for investors but allows the portfolio to move to cash more regularly, therefore reducing market risk. Additionally the movement to cash gives the portfolio manager the ability to adjust the portfolio depending on favourable market thematics or simply hold up to 100% cash if market conditions are unfavourable, something an ETF cannot do.

Exercised return = The call premium received + the capital gain from the difference between purchase price of shares and strike/exercise price of option contract.

Actual trade completed in Harbourside Capital IA Strategy 22.4.2016;

Buy 1000 LLC @ $12.55*($12,550)/ Sell 10 LLC 26th May $12.75 call options @ 32 cents*
Income return = 32 cents x 1,000 = $320 or 2.55% ($320 / $12,550*100)
Exercised return = (32 cents + ($12.75 - $12.55)) x 1,000 shares = $519.57 or 4.14%

Note: If at the close of trade on the 26th May LLC shares close above $12.75 the exercised return of 4.14% will be achieved i.e. the investor sells 1,000 LLC shares @ $12.75.

* Interactive Brokers 22.4.2016 all figures are before costs.

So how can investors have an ETF like investment but have a more active approach to potentially accelerate their income returns via a buy write strategy? The HarbourSide Income Accelerator Strategy.

Visit the link below for more information or email info@hscapital.com.au


HarbourSide Capital Pty Ltd (ACN: 166 765 537) an Authorised Representative (AR No. 448907) of HLK Group Pty Ltd (ACN: 161 284 500) which holds an Australian Financial Services Licence (AFSL no. 435746). Any information or advice contained on this marketing material is general in nature only and does not constitute personal or investment advice. All securities and financial products or instruments transactions involve risks

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