Everybody knows that Investors need predictable income. Ten thousand people a day are retiring for the next 25 years, and every single one of them is going to need predictable income. So, it should come as no surprise that when we invented HANDLS Indexes, our own market research confirmed that people wanted predictable income.
And that got us looking at yield
The solution to the lack of yield has been to chase risk. Modern Portfolio Theory, however, directs us to concentrate on total return. Investors should have no preference for yield over price return, and all else being equal, an investor is better off being diversified rather than accepting the risk of a concentrated bet on high-risk assets.
Yield is just a number because total return determines the amount of resources an investor has available for income. Investors who need predictable monthly cash flows are better served by pairing a portfolio that generates high risk-adjusted returns with a target or managed distribution rate than by chasing concentrated pools of high-risk assets.
The solution that HANDLS Indexes sought to deliver was steadiness with predictability. In other words, an outcome that might look a lot like this:
Figure 1: Monthly Distribution and NAV for the Strategy Shares Nasdaq 7HANDL Index ETF (HNDL), the first ETF to license HANDLS Index technology.
Predictability makes HANDLS an effective tool
The HANDLS solution was modeled after closed-end funds, an effective way to create high distributions. Unfortunately, the CEF structure adds return-free risk from premium/discount volatility, which according to our research, averaged about 40% of the total volatility of investing in a basket of Closed-end Funds. With HANDLS, we sought to replicate the economic exposure of a basket of funds while eliminating the shortcomings of premium/discount volatility by using a more liquid underlying. By substituting low-cost, transparent ETFs for CEFs, we found that we could reduce the experienced premium/discount volatility.
And, voila, high-distribution and liquid solutions, now better known as HANDLS, were born
The HANDLS™ solution consists of three critical components:
- A common, well-diversified, multi-asset portfolio of low-cost ETFs that seeks to maximize risk-adjusted returns.
- The potential introduction of leverage or deleverage to a desired risk level; and
- A high, targeted, managed distribution rate that seeks to systematically monetize the expected total return over time.
All of which has been incorporated into an index
Indexes have well-defined rules that can be used to implement sound practices, like monthly rebalancing, which is consistently harvesting gains while resetting to the desired allocation. This can be enhanced by aligning index rules with investor objectives and the nuances of a product’s packaging. While the individual components of HANDLS Indexes can be purchased by anyone, the process of converting total return to income while remaining optimally balanced and deploying leverage requires a lot of moving parts that unequivocally cannot yet be accomplished as efficiently outside of an investment company wrapper.
For example, ETFs have well-documented advantages regarding tax treatment that we believe could be used to defer taxes, potentially forever, using constructive return of capital to fund a minimum distribution.
By using a monthly rebalance, HANDLS reset to optimality each month while coordinating liquidity to fund the monthly distribution. Once replicated in an ETF, investors are deploying a systematic, short-term trading strategy-driven automatically by the index while deferring the recognition of long and short-term capital gains. Furthermore, the underlying constituents are all ETFs that hold thousands of individual securities, each operating tax-efficiently and experiencing the lowest possible transactional friction.
Therefore, the manager replicating HANDLS can accomplish investor objectives, not despite being a fund of funds, but BECAUSE it is a fund of ETFs. This can and probably will lead to a return of capital, but it is important to distinguish between constructive and destructive return of capital; what happens to Net Asset Value (NAV) is what really matters.
7HANDL = 1.3x5HANDL
Both the 7HANDL and the 5HANDL use the same constituents in the same proportions. Therefore, the 5HANDL and 7HANDL will be highly correlated, and the 5HANDL will be 23% less volatile than the 7HANDL.
Figure 2 One Day Comparison 5HANDL and 7HANDL Indexes
Figure 3 5-Day Comparison 5HANDL and 7HANDL
Because All HANDLS indexes are built off the same base index with the same constituents, rebalance and distribution schedule, these indexes, and consequently the products that replicate them, work together well. For example, averaging the 5HANDL and 7HANDL produces a 6HANDL ((5+7)/2=6HANDL). The math holds true to achieve any target level of risk and return. An 80/20 split between and 7 and 5HANDL would create a 6.60HANDL. By deleveraging, an investor can simultaneously lower risk and the distribution rate. An 80% 5HANDL and 20% cash combo effectively creates a 4HANDL.
HANDLS gives you the ability to target a distribution rate
From a risk-adjusted perspective, over the long term, the basket always outperforms; that is what it means when people say that diversification is the only free lunch in investing.
The 7HANDL Index and its benchmarked ETF, the Strategy Shares Nasdaq 7HANDL Index ETF (HNDL), demonstrated that the concept works as both an index and in real-world replication. Now with the addition of the 5HANDL Index, the benchmark index for the brand new Strategy Shares Nasdaq 5HANDL Index ETF (Ticker: FIVR), HANDLS is evolving to a scalable framework for benchmarking yield as an absolute number; 5 and 7, each fully replicable and both capable of working together to deliver a target distribution.
A logical approach to achieving cash flow needs
HANDLS combines a systematic, disciplined approach, a strict adherence to monthly optimality and a foundation built on everything we know about modern portfolio theory:
- Total return is what matters
- Diversification is the only free lunch in investing, and
- Yield is just a number.
HANDLS Indexes receives compensation in connection with licensing its indices to third parties. Any returns or performance provided within are for illustrative purposes only and do not demonstrate actual performance. Past performance is not a guarantee of future investment results. It is not possible to invest directly in an index. Exposure to an asset class is available through investable instruments based on an index. HANDLS Indexes does not sponsor, endorse, sell, promote or manage any investment fund or other vehicle that is offered by third parties and that seeks to provide an investment return based on the returns of any index. There is no assurance that investment products based on an index will accurately track index performance or provide positive investment returns. HANDLS Indexes is not an investment advisor, and HANDLS Indexes makes no representation regarding the advisability of investing in any such investment fund or other vehicle. A decision to invest in any such investment fund or other vehicle should not be made in reliance on any of the statements set forth in this document. Prospective investors are advised to make an investment in any such fund or other vehicle only after carefully considering the risks associated with investing in such funds, as detailed in an offering memorandum or similar document that is prepared by or on behalf of the issuer of the investment fund or other vehicle. Inclusion of a security within an index is not a recommendation by Indexes to buy, sell, or hold such security, nor is it considered to be investment advice. The information contained herein is intended for personal use only and should not be relied upon as the basis for the execution of a security trade. Investors are advised to consult with their broker or other financial representative to verify pricing information for any securities referenced herein. Neither Indexes nor any of its direct or indirect third-party data suppliers or their affiliates shall have any liability for the accuracy or completeness of the information contained herein, nor for any lost profits, indirect, special or consequential damages. Either Indexes or its direct or indirect third-party data suppliers or their affiliates have exclusive proprietary rights in any information contained herein. The information contained herein may not be used for any unauthorized purpose or redistributed without prior written approval from HANDLS Indexes.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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