It’s Good to be King

USA

CBOE joins the ETF game

CBOE Vest, owned by the same parent company that owns ETF.com and the BATS exchange, is branching out into ETFs and offering one of its mutual funds as an ETF.

The CBOE Vest S&P 500 Dividend Aristocrats Target Income Index ETF (KNG) will track an index produced by CBOE that tries to give 3% more income than the S&P 500 while also providing capital growth equal thereto.

KNG will do this by synthesising two income strategies. The first targets dividends by investing on an equal-weighted basis in the S&P 500 Dividend Aristocrats Index. The index will be rebalanced quarterly and reconstituted annually.

The second income stream comes from selling call options on the stocks held by the fund. No more than 20% of the notional value of the fund will have call options sold on it, the prospectus says. The number of call options sold will be determined by the dividends paid by the stocks and how much more income is needed to hit the 3% target yield.

KNG will list on BATS and therefore might not have to pay listing fees.

Analysis – Right to Rule?

ETF issuers are taking tickers ever more seriously as marketing devices. And KNG – with no shortage of self-confidence – appears to be doing so too. But will KNG be king?

There’s less than a year’s worth of performance data for the mutual fund version of KNG (mutual fund ticker: KNGLX). But what’s available suggests that the fund has underperformed the index, as Jack Bogle would have predicted. Why might this be? A likely reason is that dividend achievers/aristocrats are hard to predict and harder still to develop an accurate index methodology for. What attempts have been made thus far have mostly failed to beat the plain old market-weighted indexes.

Another reason might be the quarterly rebalancings, which pile up transaction costs and eat away performance. Another might be that covered call strategies are meant for bear markets (but here, short selling works better and comes with lower costs) and the past five years has been anything but. Nonetheless, our finger in the air tells us that, interesting and sophisticated though it is, KNG will have a hard time beating the index. But good luck to CBOE nonetheless.