Amplify High Income ETF (YYY): Decaying Capital And Income

I wrote in December an article on YYY with a sell rating. This one revisits this fund of fund with updated data and confirms my opinion.

YYY strategy and portfolio

Amplify High Income ETF (NYSEARCA:YYY) is a fund of closed-end funds tracking the ISE High Income Index since 6/21/2013. Amplify ETFs website describes the underlying index as a selection of high rank CEFs based on yield, discount to net asset value, and liquidity. With monthly distributions and a 30-day SEC yield of 8.72%, YYY is a product clearly targeted at income-seeking investors. Like all funds of funds adding their own management fee to acquired fund fees, the total expense ratio is expensive: 2.26%.

YYY holds closed-end funds representing a variety of asset classes, strategies and asset management companies. Eligible funds must be listed in the U.S., have a market capitalization of at least $500 million and an average daily trading value of at least $1 million. Then, they are ranked combining 3 factors: yield, discount to NAV and liquidity. Finally, constituents are weighted based on their ranks, with some tweaks.

The fund has changed names in 2019, but it has kept the same ticker and methodology. In July 2021, it changed methodologies. The most notable modifications are:

• An increase in the number of holdings to 45 (formerly 30).
• A weight limit at 3% of asset value on reconstitution.
• A semi-annual reconstitution instead of annual.

As of writing, the largest position weighs about 3% of the portfolio. The top 10 holdings, listed below with their yields and discounts to NAV (premium when negative), have an aggregate weight about 31% of asset value.

According to my calculations, the weighted average discount to NAV of all holdings is about 7.2%, almost identical to the average of the total closed-end fund universe (7.25%).

Decaying capital

The distribution yield looks attractive, but the total expense ratio of 2.26% is prohibitive. Moreover, YYY has lagged the S&P 500 (SPY) in total return by a wide margin since inception (6/21/2013) and has suffered deeper drawdowns.

Data calculated with Portfolio123

The annualized return reinvesting all distributions, without paying any tax on them, is far below the current distribution rate and the historical average rate (which is about 8.5%). It means YYY has paid a high yield while the principal has suffered a steady decay. The share price has lost 31.6% since inception:

The next table compares YYY since inception with a subset of the closed-end fund universe: the CEFs with an average liquidity above $100,000 per day and a positive discount to NAV (net asset value). The subset is rebalanced annually in equal weights.

Past performance is not a guarantee of future returns. Data Source: Portfolio123

YYY underperforms this benchmark in annualized return and in risk-adjusted performance (Sharpe ratio).

Decaying income stream

The monthly distribution averaged $0.19 per share in 2013, it is $0.12 in 2022. Since inception, YYY shareholders have lost about 37% in monthly income before accounting for taxes and inflation.

The period from 2013 to 2020 was a low-rate, low-inflation environment. Rising rates may result in higher leveraging costs, and share price decreasing faster. It may accelerate the loss of capital and income stream in nominal value for YYY shareholders, and even more in inflation-adjusted value. YYY might be used as an instrument for swing trading or tactical allocation, but it doesn’t look like a sustainable source of income for the long term. This is true for a number of high-yield instruments, not only YYY.

A dynamic strategy aiming at offsetting decay:

Capital and income decay is a structural issue in many closed-end funds, even without an additional ETF layer like YYY or PCEF (reviewed here). However, it is not inexorable if one knows how to trade CEFs instead of using them as buy-and-hold instruments. I designed a 5-factor ranking system statistically related to forward returns across the full CEF universe, and started publishing the 8 best ranked liquid CEFs for Quantitative Risk & Value subscribers in March 2020. The list is updated every week. It is not a model portfolio: trading the list every week is too costly and risky in spreads and slippage. Its purpose is helping income investors find funds with a good entry point. The table below shows the hypothetical example of starting a portfolio on 3/25/2020 with my “Best Ranked CEFs” list and updating it every 3 months since then, ignoring intermediate updates to limit transaction costs. Returns are calculated with holdings initially in equal weights without rebalancing until the next 3-month update. Dividends are reinvested at the beginning of every 3-month period.

Past performance is not a guarantee of future returns. Data calculated with Portfolio123.

The quarterly rebalanced “Best 8” beats not only YYY, but also SPY. It was a special period: most CEFs were oversold with big discounts in March 2020, so exceptional performance of QRV Best 8 CEFs in 2020 is partly due to price dislocation. Maybe it was luck, but when luck goes on, there is something else. The “Best 8” has beaten YYY in 2020, in 2021, and again in 2022 year-to-date:

Past performance is not a guarantee of future returns. Data calculated with Portfolio123.

How could the model beat YYY and SPY by such a wide margin and stay in positive territory in 2022? Short answer: the quantitative rules have resulted in a high exposure to energy funds.

The average dividend yield of the list varies around 8%. The ranking system was designed in 2016 and it has beaten CEF benchmarks out-of-sample. It takes into account NAV momentum, the discount to NAV and its mean-reversion. Going forward, I think it will not continue outperforming stocks like in the last two years, but I think it will continue outperforming YYY and high-yield ETFs in the long term. A rotational strategy in CEFs has a much better chance to protect both capital and income stream against erosion and inflation than any high-yield passive investment like YYY.