Sector ETFs

Last week at that ETF conference I was made aware of someone who is working a new type of sector ETF. I won’t say any more than that to preserve what I was told in confidence (really I was given almost no info on this).

I also had a chance to talk to a couple of the guys from PowerShares who told me that the Nasdaq BuyWrite ETF had been delayed (I did not know this). Only the S&P 500 BuyWrite ETF listed and so far it has very little in the way of assets. I think buywrite is a great tool to include in a diversified portfolio, maybe they need to do more to get the word out about the fund?

In one of the sessions last week I asked the panelists how they use ETFs to manage volatility and they all said they don’t do that. Either I asked the question poorly or they really don’t manage volatility (I suspect the former). A similar question came my way on a panel I sat on. I used the example of having owned several individual stocks for my energy sector allocation but that I worked in the WisdomTree Energy ETF (DKA) into the mix as a way to reduce volatility as the theme got longer in the tooth.

The idea of going from stocks, to ETFs and back to stocks as a means to manage through a complete stock market cycle makes a lot of sense to me.

This gets to the point of the post which is buywrite sector ETFs–for some of the sectors anyway. Buywrite is just a strategy like any other. It has pluses and minuses. The big plus is less volatile the big minus is giving away the upside beyond a certain point. It is not a strategy for all seasons but incorporated in moderation it can reduce the volatility of the portfolio.

At the beginning of or toward the middle of a stock market cycle it makes sense to take a little more risk so a sector allocation could have more common stocks and fewer ETFs and then as the cycle matures a transition to more ETFs might be the way to go. Sticking with energy, a combo of a buy write sector fund, DKA and then the smallest portion in something that is more volatile (maybe an oil sands stock for example) would bring in a lot of yield, reduce volatility some and the small portion in the (sticking with the example) oil sands could give the chance to catch some of a big bounce off the bottom in case reallocating isn’t done exactly right.

Why not just sell calls against an ETF? That could be a solution to be sure but it creates a layer of complexity and record keeping that many do-it-yourselfers may not want to do. Also a fund that does buywrite does not get called away as opposed to selling the calls yourself unless you roll up the positions which is very rarely a good idea.

The likelihood that buywrite sector ETFs ever come is quite slim but the idea is intriguing and the application has utility.

If you have any interest in any sort of ETF that does not exist I would say to let the ETF providers know about it, you never know.

Opening day for baseball, the first full day, and it looks like ESPN is back showing a lot of games again.

6 Comments

  1. Roger,

    It just seems to me that the fees associated with a buywrite ETF would be a drag on returns…

    Also am I correct in assuming these would be better in an IRA than a brokerage account?

    Thanks,

    Linda P.

    Reply
  2. Linda, sorry, I am not quite following the comment.

    Aside from the snarky everything is better in an IRA I’m not sure what you are specifically pointing to.

    I’m sure its me if you want to elaborate.

    Reply
  3. I think what Linda P. has in mind is that the payments received for writing calls is taxable as ordinary income.

    I personally like the idea of buywrite strategies. However, buywrite CEF’s have really mixed results (see for example ETW), with some trading at big discounts to NAV. Maybe ETF structures may be a better way to go.

    Reply
  4. from that standpoint, then yes, if the investor has a choice of course.

    re ETW i think the issue is more of how fear and greed in the market moves CEFs in general. look at ETFconnect for ETW and you will see the discount to NAV has gotten progressively wider–not really a problem with the fund management. The NAV is down some yes but the market price is down more.

    Reply
  5. Roger,

    I don’t see the logic in using individual stocks at the beginning of the cycle and ETF’s near the end. I agree that reducing volatility is good as the cycle progresses, but if you have confidence in your stock selections (i.e., attractive return/risk ratio), why not reduce volatility by just moving more of your portfolio into cash?

    – Adam

    Reply
  6. Adam, just simply my perception of how top down works. confidence in stocks in a falling market doesn’t mean much–my favorites could still go down a lot. also days like today; i am expecting a lot more decline but what if i am wrong? being in cash would be a problem. being in ETFs would not.

    Reply

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Sector ETFs

Last week at that ETF conference I was made aware of someone who is working a new type of sector ETF. I won’t say any more than that to preserve what I was told in confidence (really I was given almost no info on this).

I also had a chance to talk to a couple of the guys from PowerShares who told me that the Nasdaq BuyWrite ETF had been delayed (I did not know this). Only the S&P 500 BuyWrite ETF listed and so far it has very little in the way of assets. I think buywrite is a great tool to include in a diversified portfolio, maybe they need to do more to get the word out about the fund?

In one of the sessions last week I asked the panelists how they use ETFs to manage volatility and they all said they don’t do that. Either I asked the question poorly or they really don’t manage volatility (I suspect the former). A similar question came my way on a panel I sat on. I used the example of having owned several individual stocks for my energy sector allocation but that I worked in the WisdomTree Energy ETF (DKA) into the mix as a way to reduce volatility as the theme got longer in the tooth.

The idea of going from stocks, to ETFs and back to stocks as a means to manage through a complete stock market cycle makes a lot of sense to me.

This gets to the point of the post which is buywrite sector ETFs–for some of the sectors anyway. Buywrite is just a strategy like any other. It has pluses and minuses. The big plus is less volatile the big minus is giving away the upside beyond a certain point. It is not a strategy for all seasons but incorporated in moderation it can reduce the volatility of the portfolio.

At the beginning of or toward the middle of a stock market cycle it makes sense to take a little more risk so a sector allocation could have more common stocks and fewer ETFs and then as the cycle matures a transition to more ETFs might be the way to go. Sticking with energy, a combo of a buy write sector fund, DKA and then the smallest portion in something that is more volatile (maybe an oil sands stock for example) would bring in a lot of yield, reduce volatility some and the small portion in the (sticking with the example) oil sands could give the chance to catch some of a big bounce off the bottom in case reallocating isn’t done exactly right.

Why not just sell calls against an ETF? That could be a solution to be sure but it creates a layer of complexity and record keeping that many do-it-yourselfers may not want to do. Also a fund that does buywrite does not get called away as opposed to selling the calls yourself unless you roll up the positions which is very rarely a good idea.

The likelihood that buywrite sector ETFs ever come is quite slim but the idea is intriguing and the application has utility.

If you have any interest in any sort of ETF that does not exist I would say to let the ETF providers know about it, you never know.

Opening day for baseball, the first full day, and it looks like ESPN is back showing a lot of games again.

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