This ETF Offers 2-Pronged Approach

Kevin Simpson, founder and CIO of Capital Wealth Planning, is one of the portfolio managers for the $1.3 billion Amplify CWP Enhanced Dividend Income ETF (DIVO). The fund combines exposure to an actively managed portfolio of large cap dividend-paying U.S. stocks with a tactical covered call writing strategy. DIVO has outperformed the SPDR S&P 500 ETF Trust (SPY) by nearly 500 basis points year to date and has seen more than $500 million in inflows during the same period. Here, Simpson offers some insights into what’s driving those returns and how investors should view the fund. 

ETF.com: Why should investors consider a fund like DIVO in the current environment?  

Kevin Simpson: We’re very fortunate to be in the position we are, to have a strategy that’s been out for over five years and has had very solid performance in a strong rising market.

But it's really designed to help combat inflation—potentially a recession—and produce cash flow for clients in the equity income space.

When we think about DIVO, we spent a lot of time thinking about the covered call components, which is incredibly important, from the standpoint of being able to harvest volatility. You're going to see volatility for quite some time as we digest higher interest rates, inflation and probably more muted market performance. The free trade is gone; the free money is gone. Valuations matter; fundamentals matter.

Most investors are wondering, “How can I invest and combat inflation?” And it's the rising dividends piece of DIVO that’s more important than ever before.

It's not something we've really highlighted because we haven't needed to—markets were going up and we were benefiting from the rising tide lifting all ships.

But for clients looking for an increasing income stream—and that’s a true hedge against inflation—the companies that DIVO invests in have a history of increasing their dividends. And there’s no [better] inflationary hedging component [than] owning a stock that gives you a raise every year. 

ETF.com: Could you give me an example from DIVO’s portfolio? 

Simpson: McDonald's paid a $2.17 cent dividend at the end of 2016. Today, it pays a $5.52 cent dividend.

So just over the life of DIVO [which launched in December 2016], the income you've generated on owning a share of McDonald's has doubled, and there's a compounding annual growth effect to that. Literally, McDonald's has given you an 8% raise every year. 

The share price has gone up, and that's wonderful. Usually, if you own a stock that’s increasing its earnings, you'll see share price appreciation over time. But that's an incredible component having nothing to do with the covered call piece, which also right now seems very uniquely well-positioned. 

ETF.com: Tell me more about how you approach the covered call component. 

Simpson: When everything's going up there, there isn't much in the way of volatility, and in fact, covered call writing can be sometimes more counterproductive in those markets than helpful. That's why we had our tactical approach to covered call writing.

Sometimes we were accused of being too frugal. [But it] allows us to take advantage of volatility to write covered calls and to dial back when there's less volatility and markets tend to be increasing.

[It’s a] two-pronged approach—the rising dividend and the tactical covered call piece really positioned DIVO perfectly for not just the next few months of volatility, but perhaps the next few years of a market reset in terms of interest rates. 

ETF.com: What did DIVO do during the COVID-19 crash in February/March 2020? 

Simpson: Let's focus on Feb. 19 to March 23, because that was really the massive part of that correction. We captured and participated in 77% of the drawdown.

When I think of the expectations of investors and financial advisors, I look at it as a strategy that’s attempting to deliver 80-90% of market value—you get really good upside capture.

But [it’s also] trying to limit the downside capture to 65-75% of a down market, while delivering 4-7% cash flow, whether markets are up, down or sideways.

When you have a very natural short-term pullback, like we did in 2020, the covered call piece is going to have very little of a hedging benefit, because we like short-term, one-month, out-of-the money covered calls, and we only had a few covered calls written, not expecting a global pandemic and massive economic global shutdown as well as a stock market correction over a four-week period.

So having a 77% participation to the downside is really impressive. It's a little bit outside of my target, but what it illustrates is that it wasn't the covered calls that were the hedge right there—it was mostly the quality stock and the high-caliber nature of these blue chip investments that are dividend growers that inherently give you a little downside protection. They also don't go up as much as some of the growthy tech names did prior to that.

There's a lot under the hood in terms of the portfolio construction and the risk profile, which allowed us to be a limited participant in that drawdown. But in the weeks and months shortly following that, because the volatility spiked to a high of over 80, at one point, we were able to bring in call premiums that we hadn't seen since back in ’08 or ’09.

Our downside capture very quickly got back up into our range, and then from there, it was a market that was going straight up. We had to kind of reset how we manage DIVO [so we didn’t miss] completely that big, massive upsurge that we had.

And in 2021, we were able to deliver returns of over 20% because we're not just blindly writing covered calls on a systematic basis.

ETF.com: What's DIVO’s role in a portfolio?  

Simpson: I think for the investor who's a baby boomer, someone who's approaching retirement or in retirement looking for good risk adjusted returns with some cash flow, DIVO should 100% be the core equity income holding. It's not a satellite. It should be the primary focus of the equity allocation.

For younger and more aggressive investors, it might not even fit into their model. But DIVO is designed for a core equity piece. 

Contact Heather Bell at [email protected]