Exchange Traded Concepts (ETC), the firm that helps other money managers bring ETFs to market, filed paperwork with the U.S. Securities and Exchange Commission to bring to market three “Horizons” ETFs. The brand name already exists in Canada, and the three new funds, which will use covered call options to achieve their investment objectives, already exist in the Canadian market.
But the new ETFs are the first U.S.-listed funds from Horizons, a firm ultimately owned by South Korea-based Mirae Asset Management. Mirae’s U.S. unit, which also uses the Mirae name, will serve as subadvisor on the three funds, meaning it will actually run the portfolios.
ETC is labeled in the regulatory paperwork as investment advisor, as it is for all the funds it shepherds through the regulatory process using its “ETF in a Box” service. It didn’t list expense ratios or tickers in the filing. The planned U.S-listed covered-call ETFs are as follows:
- The Horizons S&P 500 Covered Call ETF
- The Horizons S&P Energy Select Sector Covered Call ETF
- The Horizons S&P Financial Select Sector Covered Call ETF
Covered-call option strategies, such as the one that the Horizons covered-call ETFs will use, are designed to enhance portfolio returns and reduce volatility. A covered-call strategy is generally used in a neutral-to-bullish market environment, where a slow and steady rise in market prices is anticipated. The advantage of a covered-call strategy is that it buffers downside volatility, although it also forfeits some upside participation in the market should the underlying securities reach their strike prices and thus be “called” by holders of the options.
The Horizons funds work by buying and holding long positions in single stocks or ETF while selling an option on the same security. When one of these funds sells (or “writes”) an option, it is obligated to sell shares of the security at a specified time in the future for a specific price. The fund makes money from the premium that the buyer pays for the right to buy the security at that price.
The prospectus describing the Horizons funds said that the underlying indexes are expected to provide higher returns with lower volatility than their broader reference indexes in most market environments, with the exception of when the equity market is rallying sharply.
Currently, there aren’t many covered-call ETFs on the market. Invesco PowerShares offers its S&P 500 BuyWrite Portfolio (NYSEArca: PBP), which is linked to the S&P 500 and sells calls against those positions. It has $146.8 million in assets under management. AdvisorShares filed paperwork last November to bring to market the Star Global Buy-Write ETF (NYSEArca: VEGA), an actively managed ETF that holds a long position in shares of its underlying ETFs, and writes call options on those assets with the goal of realizing income from the option premiums.
In January, ALPS filed paperwork to bring to market the U.S. Equity High Volatility Put Write Index Fund (NYSEArca: HPVW), which makes the opposite bet by tracking high-volatility stocks that generally experience significant declines in bear markets, but can capture significant gains when high-volatility stocks are rallying.
All three of the Horizons ETFs will be index funds with returns that correspond to the price performance and yield of their underlying S&P covered-call indexes. All the indexes comprise hypothetical portfolios that employ covered-call strategies. These portfolios include all of the securities in the broader referenced indexes as well as the call options on those securities.
Although the Horizons funds generally use a replication strategy—meaning they will invest in all of the securities companies in their underlying indexes—they may at certain times utilize sampling strategies where it’s not possible to purchase all of the equity securities in the indexes.
In addition to forfeiting some of the potential upsides in the market, investors in these funds also run the risk of bearing declines in the value of securities that the options are written on. That is because the premiums received from the options may not be sufficient to offset any losses sustained from the volatility of the underlying stocks over time.