An ETF Strategy for Today’s Choppy Markets

by Nicholas Vardy

"Nick, is there an investment strategy out there that has made money consistently, every year, over the past five years?"

My friend's question caught me off guard.

And I couldn't answer him right then and there.

However, the question intrigued me enough that I decided to research the issue.

Poring over my database of thousands of ETFs, I did find a handful of strategies that have made money over each of the past five years.

Upon reflection, I was surprised I didn't find more.

After all, we've been in the second-longest bull market of all time.

Still, there was one strategy that stood out.

And it stood out for one reason: It made money every single year over the past five years.

But it did so in spite of, and not because of, the raging bull market in U.S. stocks. It's a strategy that tends to underperform in strong bull markets.

So here's my thinking...

If this strategy made money even during a raging bull, when it should have performed poorly...

It should perform exceptionally well during choppy (or even bear) markets.

Now, you may already be familiar with this strategy.

However, for many investors, it's one that's been either too hard to understand or just too much work to implement.

So just what is this mysterious strategy?

It's called the "buy-write" or "covered call" strategy.

This strategy entails buying a stock or index and then selling covered call options against that position.

If you've ever sold covered call options on a stock, you know that you collect the "premium," or the price of the option contract, when you sell the option.

In return for the premium, you give up the upside in the stock if it goes above the option's strike price.

If that sounds too complicated, don't worry.

There is an exchange-traded fund (ETF) that implements this strategy on the S&P 500 Index for you.

Moreover, you can buy it at the click of a mouse.

Specifically, the PowerShares S&P 500 BuyWrite Portfolio Fund (NYSE: PBP) buys the S&P 500 Index.

It then sells a succession of covered call options, each with an exercise price at or above the prevailing price level of the S&P 500.

It also reinvests both the option premiums and dividends paid on the S&P 500 component stocks into the strategy, which has its attractions.

First, the S&P 500 BuyWrite Fund makes its money in a much steadier fashion than the S&P 500 does.

With a beta of 0.46, the ETF has roughly half the volatility of the S&P 500.

Second, its yield of 4.82% is well more than double that of the S&P 500.

Finally, the S&P 500 BuyWrite Fund has made money in each of the past five years, generating an average 6.93% annual return.

Now, these kinds of returns in today's markets are hardly a king's ransom.

In fact, it's only about half of what you'd have made by investing in the S&P 500.

So why am I so excited about this strategy today?

As I mentioned above, buy-write strategies tend to underperform in strong bull markets.

And as I've written before, different market types demand different strategies.

Moreover, buy-write strategies tend to outperform in sideways and declining markets.

And the S&P 500 BuyWrite Fund offers you a disciplined buy-write strategy for just such markets.

The one downside?

As far as ETFs go, PowerShares charges a hefty 0.75% annual fee - far more than what you'd pay for a basic index fund.

Still, if you consider the hassle of replicating a consistent covered call strategy on your own, I think the S&P 500 BuyWrite Fund is a bargain.

So what's the takeaway?

The buy-write strategy will never shoot the lights out.

But the S&P 500 BuyWrite Fund offers you a "set it and forget it" solution that I expect will generate consistent returns during choppy markets in the months and years ahead.

Good investing,


An Old Friend Presents a New Opportunity

ETFs are a great place to invest your money for lower fees and greater flexibility. So too are HSAs, or health savings accounts. Although less than 20% of Americans currently have HSAs, the tax benefits are causing these accounts to explode in popularity.

In April, Chief Investment Strategist Alexander Green added HealthEquity (Nasdaq: HQY) to The Momentum Alert portfolio. Here's why he thinks it's gaining strength...

Based in Draper, Utah, HealthEquity (Nasdaq: HQY) is a leading provider of health savings accounts, or HSAs.

HSAs are medical savings accounts that individuals use to pay for out-of-pocket healthcare expenses.

These accounts offer three separate tax benefits:

  1. As with an IRA or 401(k), the money you contribute to an HSA is tax-deductible.
  2. The funds in your account compound tax-deferred - and can be used to pay for future healthcare costs.
  3. The withdrawals you make - provided they are used to pay for qualified medical expenses - are also tax-free.
You can withdraw funds at any time and without penalty for copays, out-of-pocket medical, vision and dental expenses, diagnostic devices, prescription drugs, or even over-the-counter medications.

Each year more than 20 million Americans take advantage of these benefits. And HealthEquity - the single biggest provider of these accounts - is one of the few pure plays in the industry.

Although it is only a $4 billion company, it already controls more than 10% of the national market.

The numbers here are terrific. In the most recent quarter, earnings soared 45% on a 29% increase in sales. The company enjoys a 24% operating margin. And management is earning a healthy 16% return on equity.

Expect that earnings momentum to continue.

HealthEquity has boosted its sales team and is targeting smaller employers to continue gaining market share. And the company is expanding its product offerings beyond HSAs to include health reimbursement and flexible spending arrangements.

There are other reasons to remain optimistic.

Healthcare costs are rising much faster than inflation. The average retiring couple in the U.S. today is expected to face up to $220,000 in out-of-pocket healthcare costs that aren't covered by Medicare.

The prevalence of high-deductible plans is also increasing the demand for HSAs.

Today less than 20% of Americans have HSAs. But they are exploding in popularity. Assets are expected to reach $600 billion in just a few years... and then surpass $1 trillion.

This is a rapidly growing firm in a lucrative and recession-resistant industry.

- Donna DiVenuto-Ball with Alexander Green

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