YYY: Consistent High Income ETF But One To Avoid (NYSEARCA:YYY)

YYY Overview

The Amplify High Income ETF (NYSEARCA:YYY) is an ETF designed to capture high yields offered within the closed end funds – CEFs space, in a conservative manner. The lower risk approach is implemented via maintaining a very high exposure over bond CEFs versus equities. It also consists of a highly diversified portfolio with no leverage at the top level.

The CEFs making up the portfolio are determined by a quantitative approach based off the ISE High Income Index. This index “is designed to measure the returns and income of the top 45 U.S.-listed Closed-End Funds.”

What constitutes a “top” CEF is subjective, but this index places emphasis on three main characteristics. It focuses on high yields, larger discounts to NAV, and greater liquidity.

Whilst intuitively this emphasis might make sense to some, the results indicate otherwise. There is also some logic behind why such a basic approach may fail, which I shall explore further down.

Optically the double-digit annualized yield regularly on offer that gets paid monthly has appeal. The problem with this ultra consistent dividend received monthly though is that total returns are equally consistent – in a bad way. Unfortunately, over any meaningful long-term period, returns are consistently low. They barely offer any positive real returns.

YYY fund facts

The ETF has its inception date back in 2012. There is no leverage used at the top level of the structure, although the CEFs held of course may utilize leverage within their strategies.

With this fund of funds approach, YYY charges a management fee of 0.5%. The total expense ratio is listed at about 4.6% though (as per March 31 factsheet), due to the fees of the underlying funds held.

I may consider tolerating a high look through expense ratio with a fund of funds approach if there is a large underling discount to NAV of the portfolio. In this case though, I view the expense ratio as unattractive in context of an ETF which holds CEFs with an average discount of less than 5% to NAV.

There is some meaningful duration risk in the portfolio as illustrated above, so one’s own outlook for yield curve movements should be an important consideration here.

YYY performance history

Since inception (June 2012) performance numbers are listed in the table below:

The longer-term performance numbers above do not appear to be attractive in the context of the duration and credit risk one is taking here.

Maybe the since inception numbers might point to some modest returns above inflation since inception back in 2012. This, however, also requires some faith in the government’s reported inflation figures to reach such a conclusion.

Yes, holders of YYY have experienced a reasonable last 12 months. I do not consider however this is any indication though the future is now suddenly brighter for this fund. The prospects from here come down to the quantitative data with the fund’s portfolio holdings at this point in time.

In that regard, the overall portfolio trades on a rather small average discount to NAV of under 5%. I shall also go on to explain later that the risk / reward for taking on duration and credit risk in bond CEFs right now also looks unappealing.

YYY fund peers’ analysis

Another way to judge the performance of YYY is to examine some other funds that have a significant proportion of their assets in CEFs and bond-related exposures.

These other funds can use differing strategies for what they may regard as their relative “defensive” component of their portfolios.

The ideal fund comparisons to use are subjective but I have come up with the following below:

I concede that with this chosen peer group, the likes of the Cohen & Steers Closed-End Opportunity Fund ETF (NYSE:FOF) and the Saba Closed-End Funds ETF (BATS:CEFS) have a structural advantage in such comparisons. They have larger exposure to equities versus bonds compared with YYY and also the Invesco CEF Income Composite ETF (NYSEARCA:PCEF).

My point with this though is YYY does not appear to be offering much in the way of reduced volatility to compensate to any extent when we look at past performance below.

YYY’s poor long-term returns

It is a similar story if we zoom out to comparisons over the last decade where YYY total returns have even struggled to keep up with inflation. CEFS has not been around yet for a decade so is not on the below chart.

Perhaps this is an indication that bond CEFs generally charge too high fees, and a strategy of acquiring the discounted ones still will not compensate.

The exception perhaps might be in cases only when the discounts are large and abnormally wide versus previous ranges, and when shareholder activism is used as a catalyst. In this respect fund managers such as Cohen & Steers and Saba Capital are better placed to add value.

Note that from the above, FOF is structured as a CEF itself. It has tended to trade at near a 5% premium to NAV this year, so I do not view that as attractive.

The better performing CEFS is an ETF. I covered CEFS as a buy in December last year, so that would still be my preferred option out of the above.

The importance of the discount / premium to NAV in closed end funds

I generally avoid closed end funds trading at premiums to NAV which I observe with FOF right now. It does not take much to change sentiment to swing from a significant premium to a significant discount. This could be from any surprise in regard to performance of the asset class, relative performance of the fund manager, or a rights offering.

A recent example that springs to my mind is the India Fund (NYSE:IFN). I emphasized the risk of paying a large premium to NAV when discussing IFN last year. In March this year it has suddenly gone from a 17% premium to NAV to currently a 7% discount.

I mentioned earlier that YYY has at least had a satisfactory last 12 months of performance. This also partially illustrates my point in the importance of the discount to NAV. Over the last year there have been times where the CEF sector has a whole has looked more appealing due to wider than average discounts to NAV. This was a point I touched on in articles of mine late last year, as I discussed this being a tailwind for CEFS heading into 2024.

At this point in time however, if we focus on fixed income CEF discount stats, the situation looks normal. i.e. over the last few decades whether discounts have been wider or narrower in the past is close to 50/50. The same sort of potential tailwind that existed for many CEFs such as those held by YYY late last year is not so apparent now.

YYY asset class exposures

YYY distribution history

The dividend history for YYY highlights a trap not uncommon for closed end funds. It has delivered a very consistent high monthly dividend payment. This I assume is intended to be a feature of the product. Given the long-term returns achieved however, I would describe this as more of a gimmick.

Long term results indicate structural flaws in the YYY strategy

Let’s take a step back and examine the strategy focusing on high yields, larger discounts to NAV, and greater liquidity.

As explained under the previous heading, a high yield in many cases does not necessarily reflect cheap valuations and good future performance prospects.

The larger the discount to NAV can at times reflect better underlying value but this issue is more nuanced. Late last year I argued generally the closed end fund space represented more value than usual. The number of equities CEFs trading at discounts were only a larger proportion in less than 5% of times observed in the previous decades.

It also varies depending on each fund. Some CEFs trade at 10% discounts to NAV that I would argue should even trade at even wider discounts. This may be due to poor performance, high fees, and poor corporate governance. This is where a quantitative approach to investing in CEFs may not make so much sense when analyzing subjective matters.

Lastly the strategy of focusing on the more liquid CEFs is in part chosen because running any ETF requires a certain amount of underlying liquidity. The more liquid opportunities though may not be the best risk / reward setups that a smaller individual investor could take advantage of themselves.

Is now a good time to have a high exposure to bonds?

The latest exposures listed on the YYY product website has it invested 86% in bonds versus 14% in equities, so the above question is important.

The current 10-year US treasury yield of circa 4.5% in recent weeks is somewhat in the middle of the 4 to 5% range seen mostly over the last year.

I view there to be upsized risks to yields here in the context of higher-than-expected inflation being reported this year.

Another concern is the structural lack of buying of US treasuries observed from the likes of Japan and China compared to years gone by. The extent to which is highlighted from the below stats from the previously mentioned link:

“These are big numbers, but Japan’s presence in the U.S. bond market has greatly diminished over the years. In August 2004, Japan owned 18.2% of all Treasury securities outstanding. That’s now barely 4%.

This reflects a broader trend. China once held 14% of all outstanding Treasuries but now holds less than 3%, and foreign central banks’ share of all outstanding Treasuries has shrunk to 14% from a record 40% in June 2008.”

With YYY running a duration of nearly 5 years, the above warrants caution.

Credit spreads are tight

Not only are there some upside risks to the US treasury yield curve, risks appear to the upside in terms of credit spreads.

YYY top holdings

Conclusion

YYY has had some reasonable performance over the last 12 months, contrary to its longer-term numbers. As a result, I would consider it a sell on the basis that structural weakness remains, together with the backdrop of a weak outlook for bond CEFs.

In the positive scenario for YYY where bonds perform well and CEF discounts contract, investors are likely better served in other similar products mentioned anyway.