$TLTW is the iShares 20+ Year Treasury Bond BuyWrite Strategy ETF. It's essentially a covered call strategy written on top of long-term Treasury bonds. I do like the fund and the way it's constructed and the trailing 12-month distribution yield of more than 17% has certainly attracted attention! But it is a covered call ETF and those don't tend to provide much downside protection in down markets.
With a distribution yield still in the 15-20% range, there's a lot of leeway to make it a successful trade versus $TLT. That ETF is yielding 5% right now, so investors could experience a 10% share price drawdown in $TLTW and still come out ahead over $TLT. Both funds currently have a duration of around 16 years, which means the share price should change by about 16% for every 1% move in interest rates. Taking the math a step further, that means a 0.63% rise in interest rates would, in theory, result in roughly a 10% share price decline, which could be considered the "breakeven" in the $TLT vs. $TLTW discussion (for a 12-month period).
On the other hand, the drawback of covered call ETFs is that they give up most, if not all, share price upside in exchange for the higher yield. If the flight to safety trade kicks in and long-term Treasuries rally, there's a good chance that $TLT comes out ahead because it would capture the share price gains that $TLTW wouldn't. It really comes down to personal preferences for which side of the debate is better for you.
I'm not really in the business of making specific calls, but I do think that $TLTW is an attractive fund for what it offers. Income investors should at least consider it and long-term investors might also enjoy adding a high yield that adds a little diversification. For the record, I think there's a good chance that Treasuries rebound over the next 6-12 months as recessionary pressures grow. I couldn't tell you whether $TLT or $TLTW will outperform over that time because my crystal ball is kind of foggy. The last 12-18 months have undoubtedly been painful for Treasury owners, but if your objective/outlook hasn't really changed, I don't see a need to immediately run out and dump your shares just because you're sitting on a paper loss at the moment.
Here's a question I received via email (lightly edited for clarity)...
"I have an IRA account which consists of all ETFs. I am a Schwab member, and my account consists of 5 ETFs as follows - SCHG, SCHV, SCHF, SCHA, SCHE. My question is I have drawdown of about 23%. Wondering if I should sell the growth because of interest rates, and possibly some value because of the bonds and just put it into one ETF. Which do you recommend? Also I have bonds SCHZ."
Without knowing specific allocations, this is a really nicely diversified simple core portfolio allocation covering all the major asset classes. I'm assuming you own both SCHG and SCHV in order to tilt in one direction or another based on the questions you have.
Disclaimer first: My thoughts are just my thoughts, not recommendations. That being said, my opinion is that equities are looking like they could be in a rough spot over the next 6 months or so. The positive GDP growth rate and tight labor market are masking a lot of deteriorating data that suggests a recession is probably a greater than 50% likelihood at this point.
Growth stocks aren't quite as expensive as they were during the post-COVID bull market, but they're still quite expensive by historical standards. This goes double for the "magnificent 7" mega-caps. We're seeing today with Google what can happen to an overpriced growth stock on even a hint of disappointing news. Your logic is pretty sound. Growth companies use debt to finance growth. Higher interest rates means that debt is more expensive. Therefore, it's a negative to the bottom line. I think the recession possibility is a bigger downside catalyst, but high rates will also have an impact.
People often view value stocks as a safety valve in a down market since they should, in theory, have less to fall. In reality, it's important to look at the composition of a value stock portfolio. In SCHV, the two biggest sector allocations are financials and industrials with a combined 1/3 of the portfolio's allocation. Those are both cyclical sectors and will decline, perhaps severely, in a cyclical downturn. Big bank stocks are already doing pretty poorly and industrials have been lagging the S&P 500 for a few months. If you're looking for a defensive positioning, you might be better served with a low volatility strategy, such as SPLV, instead of value for downside protection.
In terms of the bond allocation, I think Treasuries are due for a rebound, but corporate bonds might have more downside left. Despite the recent past, investors often flock to Treasuries for safety in market downturns and I think they'll eventually get there in this market as well. Corporate bonds are exposed to credit risk and that could prevent this group from experiencing a similar rally. If you want corporate bond exposure, something like QLTA, which sticks with A-rated to AAA-rated debt, might be preferable.
For me personally in my portfolio (again, not a recommendation), I've added T-bills in the past couple months. I feel more comfortable locking in the 5.5% yield for the next 12 months and reassessing the landscape again when they mature. I'd caution against adding too much risk here. Remember, you can do just as well minimizing downside as you can trying to maximize upside!
1. Is it time to "lock in rates"? You can get roughly 5% in treasuries, maybe 6% in investment grade corporate? Is that good enough? How long would you lock it in for?
2. What do you make of so called "capital efficient" ETFs, such as NTSX which gives you 90% stocks and 60% bonds, or newly released RSST which gives you 100% stocks and 100% managed futures? They're using "gentle leverage". Is it ok?
1. The idea of locking in current rates long-term is something I mentioned on Twitter a couple weeks ago. I have to admit that I'm intrigued about the idea of locking in a 5% yield for the next 30 years and just taking it easy. From a longer-term perspective, say 10+ years, stocks are probably more likely to outperform bonds, but there's also likely to be much more volatility along the way. It depends on where you are in your life cycle as well. Someone who's in retirement may prefer to lock in current yields whereas someone in their 20s may still prefer a 100% equity portfolio.
For me personally, I've bought some 1-year Treasuries in my IRA simply because I think the range of potential market returns over the next 12 months is incredibly wide. I chose to take some of the "flexible" money in my portfolio, lock in the 5.5% yield and call it a year (my long-term core portfolio allocation remains unchanged). I think there's a good chance that long-term Treasuries have a rally in front of them as sentiment continues to shift risk-off and like the capital gains potential should rates begin to fall.
2. Interesting that you bring up NTSX. I appeared on ETF Guide TV a few months back talking about this very ETF, so I'll drop a link for that ==> https://www.youtube.com/watch?v=5SGBh_0-8Ao. Spoiler: I like NTSX. I think it's good, not necessarily great, but I think it does one of the more effective jobs among funds that utilize leverage.
You get about 1/3 investment-grade corporate bond exposure with $BND, so there is a bit of a difference there. If things keep heading the way they seem to be, I think government and corporate bond performance diverges - the former gaining and the latter probably moving lower. In that sense, Treasuries would be the better play, but my crystal ball is usually cloudy. I'd definitely keep the credit quality on my corporate bonds high. $QLTA is a good option.
Another question via email...
"I am down 6% on $TLTW....Should I hold, add or sell?"
$TLTW is the iShares 20+ Year Treasury Bond BuyWrite Strategy ETF. It's essentially a covered call strategy written on top of long-term Treasury bonds. I do like the fund and the way it's constructed and the trailing 12-month distribution yield of more than 17% has certainly attracted attention! But it is a covered call ETF and those don't tend to provide much downside protection in down markets.
With a distribution yield still in the 15-20% range, there's a lot of leeway to make it a successful trade versus $TLT. That ETF is yielding 5% right now, so investors could experience a 10% share price drawdown in $TLTW and still come out ahead over $TLT. Both funds currently have a duration of around 16 years, which means the share price should change by about 16% for every 1% move in interest rates. Taking the math a step further, that means a 0.63% rise in interest rates would, in theory, result in roughly a 10% share price decline, which could be considered the "breakeven" in the $TLT vs. $TLTW discussion (for a 12-month period).
On the other hand, the drawback of covered call ETFs is that they give up most, if not all, share price upside in exchange for the higher yield. If the flight to safety trade kicks in and long-term Treasuries rally, there's a good chance that $TLT comes out ahead because it would capture the share price gains that $TLTW wouldn't. It really comes down to personal preferences for which side of the debate is better for you.
I'm not really in the business of making specific calls, but I do think that $TLTW is an attractive fund for what it offers. Income investors should at least consider it and long-term investors might also enjoy adding a high yield that adds a little diversification. For the record, I think there's a good chance that Treasuries rebound over the next 6-12 months as recessionary pressures grow. I couldn't tell you whether $TLT or $TLTW will outperform over that time because my crystal ball is kind of foggy. The last 12-18 months have undoubtedly been painful for Treasury owners, but if your objective/outlook hasn't really changed, I don't see a need to immediately run out and dump your shares just because you're sitting on a paper loss at the moment.
Here's a question I received via email (lightly edited for clarity)...
"I have an IRA account which consists of all ETFs. I am a Schwab member, and my account consists of 5 ETFs as follows - SCHG, SCHV, SCHF, SCHA, SCHE. My question is I have drawdown of about 23%. Wondering if I should sell the growth because of interest rates, and possibly some value because of the bonds and just put it into one ETF. Which do you recommend? Also I have bonds SCHZ."
For clarification...
SCHG - Schwab U.S. Large Cap Growth ETF
SCHV - Schwab U.S. Large Cap Value ETF
SCHF - Schwab International Equity ETF
SCHA - Schwab U.S. Small Cap ETF
SCHE - Schwab Emerging Markets Equity ETF
SCHZ - Schwab U.S. Aggregate Bond ETF
Without knowing specific allocations, this is a really nicely diversified simple core portfolio allocation covering all the major asset classes. I'm assuming you own both SCHG and SCHV in order to tilt in one direction or another based on the questions you have.
Disclaimer first: My thoughts are just my thoughts, not recommendations. That being said, my opinion is that equities are looking like they could be in a rough spot over the next 6 months or so. The positive GDP growth rate and tight labor market are masking a lot of deteriorating data that suggests a recession is probably a greater than 50% likelihood at this point.
Growth stocks aren't quite as expensive as they were during the post-COVID bull market, but they're still quite expensive by historical standards. This goes double for the "magnificent 7" mega-caps. We're seeing today with Google what can happen to an overpriced growth stock on even a hint of disappointing news. Your logic is pretty sound. Growth companies use debt to finance growth. Higher interest rates means that debt is more expensive. Therefore, it's a negative to the bottom line. I think the recession possibility is a bigger downside catalyst, but high rates will also have an impact.
People often view value stocks as a safety valve in a down market since they should, in theory, have less to fall. In reality, it's important to look at the composition of a value stock portfolio. In SCHV, the two biggest sector allocations are financials and industrials with a combined 1/3 of the portfolio's allocation. Those are both cyclical sectors and will decline, perhaps severely, in a cyclical downturn. Big bank stocks are already doing pretty poorly and industrials have been lagging the S&P 500 for a few months. If you're looking for a defensive positioning, you might be better served with a low volatility strategy, such as SPLV, instead of value for downside protection.
In terms of the bond allocation, I think Treasuries are due for a rebound, but corporate bonds might have more downside left. Despite the recent past, investors often flock to Treasuries for safety in market downturns and I think they'll eventually get there in this market as well. Corporate bonds are exposed to credit risk and that could prevent this group from experiencing a similar rally. If you want corporate bond exposure, something like QLTA, which sticks with A-rated to AAA-rated debt, might be preferable.
For me personally in my portfolio (again, not a recommendation), I've added T-bills in the past couple months. I feel more comfortable locking in the 5.5% yield for the next 12 months and reassessing the landscape again when they mature. I'd caution against adding too much risk here. Remember, you can do just as well minimizing downside as you can trying to maximize upside!
Two questions:
1. Is it time to "lock in rates"? You can get roughly 5% in treasuries, maybe 6% in investment grade corporate? Is that good enough? How long would you lock it in for?
2. What do you make of so called "capital efficient" ETFs, such as NTSX which gives you 90% stocks and 60% bonds, or newly released RSST which gives you 100% stocks and 100% managed futures? They're using "gentle leverage". Is it ok?
Great questions!
1. The idea of locking in current rates long-term is something I mentioned on Twitter a couple weeks ago. I have to admit that I'm intrigued about the idea of locking in a 5% yield for the next 30 years and just taking it easy. From a longer-term perspective, say 10+ years, stocks are probably more likely to outperform bonds, but there's also likely to be much more volatility along the way. It depends on where you are in your life cycle as well. Someone who's in retirement may prefer to lock in current yields whereas someone in their 20s may still prefer a 100% equity portfolio.
For me personally, I've bought some 1-year Treasuries in my IRA simply because I think the range of potential market returns over the next 12 months is incredibly wide. I chose to take some of the "flexible" money in my portfolio, lock in the 5.5% yield and call it a year (my long-term core portfolio allocation remains unchanged). I think there's a good chance that long-term Treasuries have a rally in front of them as sentiment continues to shift risk-off and like the capital gains potential should rates begin to fall.
2. Interesting that you bring up NTSX. I appeared on ETF Guide TV a few months back talking about this very ETF, so I'll drop a link for that ==> https://www.youtube.com/watch?v=5SGBh_0-8Ao. Spoiler: I like NTSX. I think it's good, not necessarily great, but I think it does one of the more effective jobs among funds that utilize leverage.
Great. I will check that out.
I suppose you could put some in T-bills, some in long bonds, but then I wonder if you don’t just basically own $BND.
You get about 1/3 investment-grade corporate bond exposure with $BND, so there is a bit of a difference there. If things keep heading the way they seem to be, I think government and corporate bond performance diverges - the former gaining and the latter probably moving lower. In that sense, Treasuries would be the better play, but my crystal ball is usually cloudy. I'd definitely keep the credit quality on my corporate bonds high. $QLTA is a good option.