First Trust BuyWrite Income ETF (NASDAQ:FTHI) was formed by First Trust Advisors L.P. on January 6, 2014, and is domiciled in the United States. This ETF’s primary investment objective is to provide current income, while capital appreciation remains the secondary investment objective. In order to fulfill its primary objective, FTHI invests in a combination of high dividend-paying equity shares and index options. The market value of the option strategy may be up to 20% of the Fund’s overall net asset value.
Its primary options strategy is to write (sell) U.S. exchange-traded covered call options on the S&P 500 Index in order to generate additional cash flow in the form of premiums on the options. A covered call strategy involves holding a particular stock and selling a call option on the same stock with a future exercise date. A call option buyer has the choice of exercising the option on a future date. The buyer only exercises when the spot price is higher than the exercise price, and gains from the price difference.
In case the spot price is lower than the exercise price, the option buyer stays away from exercising the option, as he/she would take a loss, as the buyer would have to pay more than the existing market price at that point in time. The call option buyer has to pay an upfront premium on the date of buying the option for the privilege. This call option premium becomes income received by the call option seller/writer.
The option writer expects the actual market price (spot price) to remain lower than the exercise price, so that the option is not exercised. However, in case the spot price is higher than the exercise price, the option writer loses out on potential gains, which gains theoretically can be unlimited. In order to safeguard from such potentially unlimited loss, the call option seller also holds the same volume of equity shares of that particular company on which he/she has written the option. This is what a covered call options strategy is. A covered call strategy is useful in generating additional income and in providing a degree of protection against short-term volatility.
The objective of the fund manager of First Trust BuyWrite Income ETF is to have a diversified portfolio with dividend-paying stocks that will seek to generate an average yield somewhere near the yield (within a difference of 3 to 5 percent) of the S&P 500 Index. The equity portfolio is periodically rebalanced and the options portfolio is actively managed, keeping in sync with the market conditions and opportunities.
First Trust BuyWrite Income ETF has been paying steady monthly dividends since its inception. FTHI’s current yield is 7.87 percent, and it has recorded an average yield of 4.81 percent over the past 12 months. Throughout its existence, average annual yield has ranged between four percent to five percent. This yield is good enough to attract income-seeking investors. An equal percentage of price growth will result in double-digit returns for the investors of this ETF.
However, FTHI’s price returns have been disappointing. As mentioned earlier, capital appreciation remains the secondary investment objective of this diversified ETF. In the more than 8 years since its inception, First Trust BuyWrite Income ETF generated a price growth of less than 15 percent. Over the past 5 years and 3-year periods, FTHI recorded a price growth of 8.5 percent and 4.4 percent, respectively. Over the past one year, FTHI’s price OTC:GREW by 7.1 percent.
Unfortunately, since the inception of this fund, the US stock market has been extremely volatile. It has witnessed three separate years of extremely poor performance of the overall US stock market – 2015, 2018, and 2020. During these three years, First Trust BuyWrite Income ETF recorded an average negative growth of 4.5 percent, which in my opinion was an acceptable performance considering the overall market scenario. However, in other years (2016, 2017, 2019, 2021), First Trust BuyWrite Income ETF successfully posted a total return of more than 12 percent.
The 2015 stock market selloff resulted from turbulence in Shanghai Stock Exchange (SSE), a fall in petroleum prices, and quantitative easing in the US market. The US equity market witnessed setbacks in 2018 due to higher tariffs, interest rate hikes, and tax cuts. In 2020, as we all know, the market fell due to the Covid-19 pandemic. The equity market crashed during March 2020 and took almost a year to recover.
First Trust BuyWrite Income ETF invests in companies engaged primarily in the business of information technology & communication (21 percent), healthcare (19 percent), and financials (17 percent). Together, these three sectors account for 57 percent of FTHI’s total holdings. Unfortunately, these stocks witness high volatility, and FTHI has been hugely impacted in those years of poor market growth. At the same time, these stock holdings were helpful in generating huge growth when the market was bullish.
The significant holdings (meaning at least 1 percent of the total portfolio) of First Trust BuyWrite Income ETF account for around one-third of its total portfolio. Out of 15 such equity shares, 13 stocks belong to these three sectors. These stocks are Apple Inc. (AAPL), Microsoft Corporation (MSFT), Wells Fargo & Company (WFC), The PNC Financial Services Group, Inc. (PNC), Alphabet Inc. Class A (GOOGL), Alphabet Inc. Class C (GOOG), Berkshire Hathaway Inc. -Class B (BRK.B), U.S. Bancorp (USB), UnitedHealth Group Incorporated (UNH), Meta Platforms, Inc. (FB), Johnson & Johnson (JNJ), NVIDIA Corporation (NVDA), and JPMorgan Chase & Co. (JPM). The other two are automobile giant Tesla, Inc. (TSLA), and e-commerce giant Amazon.com, Inc. (AMZN), which have high linkages with the technology sector.
A little over 30 percent of First Trust BuyWrite Income ETF’s investments are in basic or core industries – materials (11 percent), utilities (1 percent), energy (15 percent), real estate (1 percent) and consumer staples (2 percent). As most of these companies derive their revenue from very basic needs of people (e.g., foods, construction, gas, minerals and electricity), they are generally less impacted by an economic downturn and hence able to generate steady dividend yields.
Since its inception, First Trust BuyWrite Income ETF has generated an annual average total return of a little less than seven percent. FTHI, in my opinion, will continue to provide a yield between four to five percent on the basis of its investments in high yield stocks and premium income on selling of index options. In addition to that, its 30 percent investments over stocks of the basic sector bring significant balance to its portfolio.
As the major global economies are recovering from the Covid-19 pandemic and overcoming supply chain issues, stock markets will improve. Thus, there is no reason why First Trust BuyWrite Income ETF will not be able to continue its historical growth rate and generate an annual average steady return between six to seven percent. Now, is this return good enough for the investors? That surely depends on the expectations and risk profile of the investors.
The risk-averse steady income-seeking investors may include this ETF in their portfolio of investments. In my opinion, FTHI will be able to sustain this steady income due to its emphasis on investments in high yield stocks and premium income on writing of index options. Although FTHI’s emphasis on technology, healthcare, and financial stocks provides enough opportunity for future price growth, investors investing in this stock should not expect huge price growth because 72.57 percent of its equity investments are hedged with covered call option strategy. In case of unexpected price rise in any stock, the gain in that stock will be washed away as the call options will be exercised on that particular stock.
Will this stock suit the investment objective of risk-savvy growth-seeking investors? I don’t think so. There is little chance of earning an average double-digit return over a longer period of time. This diversified ETF is a very small fund with assets under management (AUM) of less than $50 million, which is invested over equity shares of around 225 companies covering all the sectors of the economy. Such a deep level of diversification, though helpful in reducing volatility, will not be beneficial to attain excessively high price growth. On top of that, the covered call option strategy will make excessively high returns almost impossible. Thus, I feel risk-taking, growth-seeking investors should stay away from investing in First Trust BuyWrite Income ETF.